-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Jgp7f8eNbO7R8LqMXeNMqgWa6uUxldba2i0k9IgsLqRRSF2vwkY3XYvm7RR8OmVI XyP9yGFIMo5ndeqlDma9XA== 0001020253-97-000010.txt : 19970403 0001020253-97-000010.hdr.sgml : 19970403 ACCESSION NUMBER: 0001020253-97-000010 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970401 SROS: AMEX FILER: COMPANY DATA: COMPANY CONFORMED NAME: SURETY CAPITAL CORP /DE/ CENTRAL INDEX KEY: 0000784932 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 752065607 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-12818 FILM NUMBER: 97573119 BUSINESS ADDRESS: STREET 1: 1845 PRECINCT LINE RD STE 100 CITY: HURST STATE: TX ZIP: 76054 BUSINESS PHONE: 8174988154 MAIL ADDRESS: STREET 1: 1845 PRECINCT LINE RD STE 100 CITY: HURST STATE: TX ZIP: 76054 FORMER COMPANY: FORMER CONFORMED NAME: K CAPITAL INC DATE OF NAME CHANGE: 19870407 10-K 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------------- FORM 10-K Mark One [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended December 31, 1996 --- Commission File Number 33-1983; OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period From ___________ to ___________. -------------------- SURETY CAPITAL CORPORATION -------------------------- (Exact name of Registrant as specified in its charter) Delaware 75-2065607 -------- ---------- (State of Incorporation) (IRS Employer Identification No.) 1845 Precinct Line Road, Suite 100, Hurst, Texas 76054 ------------------------------------------------------ (Address of Principal Executive Offices) (817) 498-2749 -------------- (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of each class on which registered ------------------- ------------------- Common Stock, $0.01 par value American Stock Exchange Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.01 par value Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of Common Stock held by nonaffiliates of the Registrant, based on the quoted price of the Common Stock as reported on the American Stock Exchange on March 20, 1997, was $22,097,559. For purposes of this computation, all officers, directors and 5% beneficial owners of the Registrant are deemed to be affiliates. Such determination should not be deemed an admission that such officers, directors or 5% beneficial owners are, in fact, affiliates of the Registrant. As of March 20, 1997, 5,750,554 shares of Common Stock were outstanding. Documents Incorporated by Reference: Portions of the Company's Proxy Statement dated not later than 120 days after the end of the Company's most recent fiscal year, filed pursuant to Regulation 14A of the Securities Exchange Act of 1934 for the 1997 Annual Meeting of Stockholders of Surety Capital Corporation, are incorporated by reference into Part III. PART I ITEM 1. BUSINESS. General Surety Capital Corporation (the "Company"), a corporation incorporated under the laws of the state of Delaware in 1985, is a bank holding company registered under the Bank Holding Company Act of 1956, as amended (the "BHC Act"). The Company owns all of the issued and outstanding shares of capital stock of Surety Bank, National Association, formerly Texas Bank, National Association and formerly Texas National Bank, Lufkin, Texas (the "Bank"), with full service offices in Chester, Hurst, Kennard, Lufkin, Midlothian, Waxahachie, Wells and Whitesboro, Texas. The Company's principal executive offices are located at 1845 Precinct Line Road, Suite 100, Hurst, Texas 76054, and its telephone number is 817-498-2749. The Bank's principal offices are located at 1845 Precinct Line Road, Suite 100, Hurst, Texas 76054, and its telephone number is 817-498-2749. The Company At December 31, 1996 the Company had consolidated total assets of $176,439,310, total net loans of $101,866,914, consolidated total deposits of $155,690,341, and consolidated total shareholders' equity of $19,230,552. The Company acts as a registered bank holding company under the BHC Act. The Company does not have any independent material business activities, and anticipates that its future activities will be limited to acting as a source of support for the Bank. As a result of the consolidation of the Bank and First National Bank, Midlothian, Texas, under the charter of the Bank, and under the title of "Surety Bank, National Association" effective as of the close of business on February 29, 1996, the Company owns 100% of the issued and outstanding shares of common stock of the Bank. See "Item 1. Business - Acquisitions." The Company's business is neither seasonal in nature nor in any manner related to or dependent upon patents, licenses, franchises or concessions, and the Company has not spent material amounts on research activities. The following table sets forth in summary form the revenues, expenses and income for the Company and the Bank as of, and for the year ended, December 31, 1996: Balance Sheet Data Company Only Bank Only Consolidated - ------------------ ------------ --------- ------------ Cash and Cash Equivalents $ 756,813 $ 22,866,457 $ 22,866,457 Total Net Loans 101,866,914 101,866,914 Total Assets 19,230,552 176,469,414 176,439,310 Deposits 156,447,153 155,690,341 Total Liabilities 158,151,409 157,208,758 Shareholders' Equity 19,230,552 18,318,004 19,230,552 -2- Income Statement Data Company Only Bank Only Consolidated - --------------------- ------------ --------- ------------ Interest Income $ 40,045 $14,390,362 $14,390,362 Interest Expense 6,612 5,395,122 5,361,689 Non-Interest Expense 169,610 7,999,228 8,135,012 Net Income 1,697,987 1,788,489 1,697,987 The Subsidiary Bank The Bank was chartered as a national banking association in 1963 and has its main offices located in Hurst, Texas. The Bank also operates seven (7) branches in Chester, Kennard, Lufkin, Midlothian, Waxahachie, Wells and Whitesboro, Texas. The services offered by the Bank and its branches are generally those offered by commercial banks of comparable size in their respective areas, except that a large portion of the Bank's loan portfolio represents insurance premium financing loans. Some of the major services are described below. COMMERCIAL BANKING. The Bank provides general commercial banking services for corporate and other business clients located in Tarrant County, Texas, and through its branches located in Angelina, Cherokee, Ellis, Grayson, Houston and Tyler Counties, Texas as a part of the Bank's efforts to serve the local communities in which it operates. These loans are generally made to provide working capital, to finance the purchase of equipment, and for the expansion of existing businesses. Most loans are secured by the assets of the businesses, including real estate, inventories, receivables, equipment and cash. Virtually all of these loans are also guaranteed by the owners of the businesses. The commercial loan portfolio also includes a significant amount of agricultural loans to farmers and ranchers. These loans are normally secured by equipment, crops, livestock, real estate and cash. The average yield during 1996 for the Bank's commercial lending activities was 13%. The Bank's commercial loans usually have maturities of twelve months or less. The Bank also offers programs for medical claims factoring. CONSUMER BANKING. The Bank provides a full range of consumer banking services, including checking accounts, "NOW" and "money market" accounts, savings programs, installment and real estate loans, money transfers and safe deposit facilities. INSURANCE PREMIUM FINANCING. As described in greater detail below, the Bank makes insurance premium financing loans in Texas and in other states. See "Item 1. Business - Insurance Premium Financing." At December 31, 1996 approximately 27%, 36% and 37% of the Bank's loan portfolio represented commercial banking loans, consumer banking loans and insurance premium financing loans, respectively. Acquisitions Effective as of the close of business on March 22, 1993, the Bank acquired Bank of East Texas, Chester, Texas ("Bank of East Texas") and First State Bank, Wells, Texas ("First State Bank"). The -3- acquisitions were effected by the Bank through the mergers of Bank of East Texas and First State Bank with and into the Bank. Pursuant to the mergers, the Bank paid $645,676 and $1,090,203, respectively, to the shareholders of Bank of East Texas and First State Bank. The purchase prices were based on the respective book values of the Bank of East Texas and First State Bank as of February 28, 1993, subject to certain agreed upon adjustments. The Company financed the acquisitions with internally-generated cash reserves. Effective as of the close of business on May 31, 1994, the Bank acquired The Farmers Guaranty State Bank of Kennard, Kennard, Texas ("Farmers Bank") for $1,200,000. The acquisition was effected by the Bank through the merger of Farmers Bank with and into the Bank. The purchase price was based on a multiple of the book value of Farmers Bank as of May 31, 1994, subject to certain agreed upon adjustments. The Company financed the acquisition with internally-generated cash reserves. Effective as of the close of business on December 8, 1994, the Bank acquired First National Bank, a national banking association located in Whitesboro, Texas ("First National Bank") for $6,000,000. The acquisition was effected by the Bank through the merger of First National Bank with and into the Bank. The purchase price was approximately 150% of the book value of First National Bank as of the effective date of the merger. The Company financed the acquisition in part through a private placement of its common stock, and in part through a loan from a financial institution. Effective as of the close of business on September 28, 1995, the Bank purchased certain assets and assumed certain liabilities of the branch of Bank One, Texas, National Association located in Waxahachie, Texas ("Bank One Branch"). At the closing, the Bank assumed deposits and other liabilities totaling approximately $16,539,000. In addition, the Bank acquired certain small business and consumer loans totaling approximately $875,000, certain real property, furniture and equipment totaling approximately $274,000, and cash and other assets totaling approximately $15,426,000. After paying a deposit premium of two percent (2%) on the deposits assumed totaling approximately $331,000, the Bank received approximately $15,419,000 in cash from Bank One Branch as consideration for the net deposit liabilities assumed. The Company financed the acquisition with internally-generated cash reserves. On February 29, 1996, the Company acquired First Midlothian Corporation, a Texas bank holding company located in Midlothian, Texas ("First Midlothian"), and its wholly-owned subsidiary, First National Bank, a national banking association also located in Midlothian, Texas ("First National Bank"), through the merger of a wholly-owned operating subsidiary of the Bank with and into First Midlothian. In connection with the merger, the Bank paid a total of $6,595,707, of which $5,976,000 was paid to the former shareholders of First Midlothian in exchange for their shares of common stock of First Midlothian and $619,707 was applied to the repayment in full of certain outstanding debentures of First Midlothian. The purchase price was approximately one hundred fifty percent (150%) of the book value of First National Bank as of the effective date of the merger. Following the consummation of the merger, the Bank and First National Bank were consolidated under the charter of the Bank, and First Midlothian was liquidated. The Company financed the acquisition through an $7,394,293 underwritten public offering of its shares of common stock, which closed in February 1996. Effective March 15, 1996, the Bank acquired all of the assets and assumed certain of the liabilities in the approximate amount of $50,000 of Providers Funding Corporation ("PFC"), a Dallas based medical claims servicing company, for a purchase price of $1,000,000. -4- Insurance Premium Financing Insurance premium financing involves lending money to purchasers of property and casualty insurance (the "insureds") for the payment of their insurance premiums. This is an established type of lending which has typically been provided by special purpose subsidiaries of major insurance companies and by finance companies. Insurance premium financing is generally considered a low risk form of lending for three reasons: 1. Approximately 25% of the annual premium must be paid by the insured at the time the insurance is purchased, so the amount of the loan represents only approximately 75% of the annual insurance premium. 2. At any date before the end of the policy term, a portion of the premium is not yet earned because it applies to the period from that date to the end of the policy term. This unearned premium is refunded if the policy is canceled before the end of the policy term. The amount of the premium financed is generally payable over the first nine months of the policy's term, so the unearned premium exceeds the outstanding balance of the loan and will repay the loan in full if the policy is canceled before the end of the policy term. 3. Even though the insured is responsible for repayment of the premium finance loan, if the insured does not make the loan payments on time, the lender has the right to cancel the policy (after notice to the insured) and to receive the entire amount of the unearned premium from the insurance carrier. The unearned premium is usually in excess of the loan balance, including accrued interest. The Company, and subsequently the Bank, has engaged in insurance premium finance lending since 1986, and the business has grown in terms of volume and outstanding loan balances since that time. Since its acquisition in 1989, the Bank has made all of the insurance premium financing loans. The following table shows the outstanding balance of premium finance loans at the end of each of the years indicated: INSURANCE PREMIUM FINANCE LOANS OUTSTANDING Gross Loans Year Outstanding ---- ----------- 1989 $ 4,682,321 1990 7,061,880 1991 8,265,490 1992 7,267,889 1993 14,518,680 1994 20,931,642 1995 22,409,356 1996 39,168,604 The typical insurance premium finance loan has a nine month life. Because of the need to bill policy holders and to promptly cancel policies when loan payments are not received in a timely fashion, this product requires highly sophisticated data processing systems. Over the past several years, the -5- Bank has developed a customized computer system, and has established a variety of policies and procedures that allow it to handle, on an integrated basis, all of the administrative aspects of this business. The Bank's computer system handles the preparation of loan documents, billing of insureds, preparation of notices, calculation and billing of late charges, notification of policy cancellations, and preparation of premium rebate requests to insurance companies when a policy is canceled. The insurance premium finance division is managed by G.M. Heinzelmann, III. The division's central operations department is located in the Bank's offices in Hurst, Texas. This location is staffed with nine (9) operations people and three (3) marketing managers. The division also has a loan production office in Atlanta, Georgia. The Atlanta office is currently staffed with a regional manager, two (2) part-time employees, and four (4) marketing managers. The marketing managers devote all of their time to developing and maintaining the Bank's relationships with insurance companies, insurance brokers, and insurance agencies. Currently the Bank has active relationships with approximately 600 insurance companies and approximately 5,000 insurance agents. These parties refer insurance purchasers who request financing to the Bank, although in most cases the relationships are not exclusive. A majority of the insurance premiums are financed by the Bank and relate to commercial property and casualty policies. Since the premiums on these policies can be quite high, many businesses prefer to pay the premiums over the course of the policy life rather than to pay the entire premium at the time the policy is purchased. Since the Bank relies on rebates of the unearned premiums as collateral to pay off defaulted insurance premium loans, the Bank evaluates the financial strength of the insurance companies as well as each insured. In order to avoid excessive concentrations, the Bank limits the dollar amount of premium financing for policies written by any single insurance company. The Bank's current policy limits the aggregate loans related to any single insurance company or any insurance syndicate to a maximum of 35% of the Bank's capital. The 35% limit applies only to insurance companies rated "A" or better by A. M. Best & Company, Inc. ("Best"), and to certain unrated insurance organizations which the Bank's management has determined to be financially strong. Lower percentage limits apply to insurance companies which have ratings of less than "A" from Best or are not rated by Best. For example, the aggregate premium loans related to any insurance entity that is not rated by Best and is not admitted in Texas may not exceed 10% of the Bank's capital unless the Bank's board of directors authorizes a higher limit based on a review of the insurer, principally concerning its financial strength. Best is the most widely recognized rater of insurance companies in the United States. Best only rates companies that have been in business for five years, and these companies are rated using the following system: A++, A+ Superior A, A- Excellent B++, B+ Very Good B, B- Adequate C++,C+ Fair C, C- Marginal In addition to these ratings, Best has a variety of ratings for companies for which the standard ratings are not applicable. These additional ratings simply indicate the reason no rating is assigned and -6- are not necessarily qualitative assessments. The following table provides a breakdown of the Bank's insurance premium financing loans outstanding as of December 31, 1996 by the type and, where applicable, the rating of the entity providing the insurance: Insurance companies rated AA++, A+, A or A- by Best 71.0% Insurance companies rated AB++, B+, B or B- by Best 6.0% Texas Workers Compensation Insurance Fund 5.3% Insurance syndicates operating through established 5.3% insurance exchanges Non-rated insurance companies admitted in Texas 7.4% Non-rated insurance companies not admitted in Texas 5.0% ------ Total 100.0% ====== Management believes the structure of these loans results in limited credit losses. The Bank may incur losses in its insurance premium financing business for a number of reasons, including fraud, refusal of an insurance company to refund a premium, insurance company insolvency, failure of the Bank to properly notify an insurance company of the Bank's interest in unearned premiums under applicable law and other reasons. The Bank's loss experience on insurance premium finance lending was adversely affected during the second half of 1991 by the failure of a non-rated insurance company. Since 1991, the Bank has limited its exposure to non-rated companies, as described above, and has experienced no net credit losses on premium financing loans. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Allowance for Credit Losses." Medical Receivables Factoring The Bank has engaged in medical receivables factoring since 1990. Medical receivables factoring involves the purchase of accounts receivable from doctors, hospitals, and other health care organizations. These accounts receivable are due principally from major insurance companies and governmental agencies, and are purchased by the Bank at a price equal to approximately 50% to 60% of their face amount. When the receivable is paid the Bank retains the purchase price it paid for the receivables plus a discount factor and a servicing fee. The remaining balance of the payment is paid to the party from which the receivable was initially purchased. The turnover in the Bank's medical receivables portfolio is rapid and is attributable to each factored receivable having an average life of approximately nine weeks. During the year ended December 31, 1996, the yield on the funds committed to this activity was 37.8%. During the first quarter of 1996, the administration of the medical receivables was handled by Providers Funding Corporation ("PFC"), a company which specialized in the acquisition and processing of medical receivables. PFC developed specialized computer systems to automate much of the administration of the medical receivables. In addition to a review of the receivables conducted by PFC, the Bank had two employees conduct a secondary review of the receivables to make sure they met the Bank's criteria. Effective March 15, 1996, the Bank acquired PFC, which is now operated as a division of the Bank and now conducts in-house the acquisition and processing of medical receivables. The Bank has experienced no material losses in its medical receivables factoring business since the Bank began this type of lending in 1990. The only losses experienced by the Bank in its medical -7- receivables factoring business occurred in the second half of 1996 and amounted to $12,724. However, the Bank could incur losses in its medical receivables factoring business for a number of reasons, including fraud and the failure of the insurance company or the government agency to pay the receivable for any reason. The Bank generally has no recourse against the health care provider for payment of a medical receivable which is not otherwise paid, although the Bank generally obtains and perfects a security interest in all medical receivables of that health care provider to secure payment of the receivables. Therefore, payments on any other receivable in excess of the balance due the Bank regarding that receivable may, under certain circumstances, be applied to an unpaid receivable. Medical receivables factoring, like insurance premium financing, is a specialty type of financing which provides high yields and requires specialized expertise and systems. The Bank considers the market for this type of financing to be relatively broad, and to extend beyond the local markets served by its branches. Competition There is significant competition among banks and bank holding companies in Angelina, Cherokee, Ellis, Grayson, Houston, Tarrant and Tyler Counties, Texas, and the Bank believes that such competition among such banks and bank holding companies, many of which have far greater assets and financial resources than the Bank, will continue to increase in the future. The Bank also encounters intense competition in its commercial and consumer banking business from savings and loan associations, credit unions, factors, insurance companies, commercial and captive finance companies, and certain other types of financial institutions located in other major metropolitan areas in the United States, many of which are larger in terms of capital, resources and personnel. The casualty insurance premium financing business of the Bank is also very competitive. Large insurance companies offer their own financing plans, and other independent premium finance companies and other financial institutions offer insurance premium financing loans. Employees As of December 31, 1996 the Company and the Bank had one hundred thirty one (131) full-time employees and two (2) part-time employees. None of the Company's or the Bank's employees are subject to a collective bargaining agreement, and the Company and the Bank believes that their respective employee relations are good. SUPERVISION AND REGULATION General The Company and the Bank are subject to the generally applicable state and federal laws governing businesses and employers. The Company and the Bank are further extensively regulated by special state and federal laws and regulations applicable only to financial institutions and their parent companies. Virtually all aspects of the Company's and the Bank's operations are subject to specific requirements or restrictions and general regulatory oversight, from laws regulating consumer finance transactions, such as the Truth in Lending Act, the Home Mortgage Disclosure Act and the Equal Credit Opportunity Act, to laws regulating collections and confidentiality, such as the Fair Debt Collection Practices Act, the Fair Credit Reporting Act and the Right to Financial Privacy Act. With few exceptions, state and federal banking laws have as their principal objective either the maintenance of the safety and soundness of financial institutions and the federal deposit insurance system or the protection of consumers or classes of consumers, rather than the specific protection of shareholders of the Company. -8- To the extent the following discussion describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statute or regulation. Any change in applicable laws, regulations or policies of various regulatory authorities may have a material effect on the business, operations and prospects of the Company and the Bank. The Company is unable to predict the nature or the extent of the effects on its business or earnings that fiscal or monetary policies, economic control or new federal or state legislation may have in the future. Federal Bank Holding Company Regulation The Company is a bank holding company within the meaning of the BHC Act, and therefore is subject to regulation and supervision by the Board of Governors of the Federal Reserve System (the "FRB"). The Company is required to file reports with, and to furnish such other information as, the FRB may require pursuant to the BHC Act, and to subject itself to examination by the FRB. The FRB has the authority to issue orders to bank holding companies to cease and desist from unsound banking practices and violations of conditions imposed by, or violations of agreements with, the FRB. The FRB is also empowered to assess civil monetary penalties against companies or individuals who violate the BHC Act or orders or regulations thereunder, to order termination of non-banking activities of non-banking subsidiaries of bank holding companies, and to order termination of ownership and control of a non-banking subsidiary by a bank holding company. Certain violations may also result in criminal penalties. The Office of the Comptroller of the Currency ("OCC") is authorized to exercise comparable authority with respect to the Bank. The FRB takes the position that a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. In addition, it is the FRB's position that, in serving as a source of strength to its subsidiary banks, a bank holding company should stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company's failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the FRB to be an unsafe and unsound banking practice or a violation of the FRB regulations or both. This doctrine has become known as the "source of strength" doctrine. In addition, statutory changes in the Federal Deposit Insurance Act (the "FDIA") made by the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA") now require the holding company parent of an undercapitalized bank to guarantee, up to certain limits, the bank's compliance with a capital restoration plan approved by the bank's primary federal supervisory agency. The BHC Act and the Change in Bank Control Act, together with regulations promulgated by the FRB, require that, depending on the particular circumstances, either FRB approval must be obtained or notice must be furnished to the FRB and not disapproved prior to any person or company acquiring "control" of a bank holding company, such as the Company, subject to certain exemptions for certain transactions. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the bank holding company. Control is rebuttably presumed to exist if a person acquires 10% or more but less than 25% of any class of voting securities and either the company has registered securities under Section 12 of the Securities Exchange Act of 1934, as amended, or no other person will own a greater percentage of that class of voting securities immediately after the transaction. The regulations provide a procedure for challenge of the rebuttable control presumption. Control is rebuttably presumed not to exist if a company acquires less than 5% of any class of voting securities of a bank or a bank holding company. -9- As a bank holding company, the Company is required to obtain approval prior to merging or consolidating with any other bank holding company, acquiring all or substantially all of the assets of any bank or acquiring ownership or control of shares of a bank or bank holding company if, after the acquisition, the Company would directly or indirectly own or control 5% or more of the voting shares of such bank or bank holding company. The Company is also prohibited from acquiring a direct or indirect interest in or control of more than 5% of the voting shares of any company which is not a bank or bank holding company and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks or furnishing services to its subsidiary banks, except that it may engage in and may own shares of companies engaged in certain activities found by the FRB to be so closely related to banking or managing and controlling banks as to be a proper incident thereto. These activities include, among others, operating a mortgage, finance, credit card, or factoring company; performing certain data processing operations; providing investment and financial advice; acting as an insurance agent for certain types of credit-related insurance; leasing personal property on a full-payout, non-operating basis; and providing certain stock brokerage and investment advisory services. In approving acquisitions or the addition of activities, the FRB considers whether the acquisition or the additional activities can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition, or gains in efficiency, that outweigh such possible adverse effects as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices. In considering any application for approval of an acquisition or merger, the FRB is also required to consider the financial and managerial resources of the companies and the banks concerned, as well as the applicant's record of compliance with the Community Reinvestment Act of 1977 (the "CRA"). As of December 31, 1995, the Riegle-Neal Interstate Banking and Branching Act of 1994 (the "Interstate Banking Act") allows adequately capitalized and managed bank holding companies to acquire banks in any state, regardless of whether the acquisition would be prohibited by applicable state law. An out-of-state bank holding company seeking to acquire ownership or control of a Texas state bank, a national bank located in Texas or any bank holding company owning or controlling a state bank or a national bank located in Texas must obtain the prior approval of both the FRB and the Banking Commissioner of Texas. In addition, under the Interstate Banking Act, a bank holding company and its insured depository institution affiliates may not complete an acquisition which would cause it to control more than 10% of total deposits in insured depository institutions nationwide or to control 30% or more of total deposits in insured depository institutions in the home state of the target bank. However, state deposit concentration caps adopted by various states, such as Texas, which limit control of in-state insured deposits to a greater extent than the Interstate Banking Act will be given effect. Texas has adopted a deposit concentration cap of 25% of in-state insured deposits; therefore, the Texas state deposit concentration cap will lower the otherwise applicable 30% federal deposit concentration cap. Additionally, state provisions regarding the minimum years the target has been in existence will be honored; provided, however, acquisitions may be approved when the target bank has been in existence for at least five years, notwithstanding state provisions to the contrary. The minimum age provision adopted by Texas is five years and therefore this provision will not be preempted by the federal provision. The Interstate Banking Act will also allow out-of-state branches through interstate mergers commencing June 1, 1997, provided that each bank involved in the merger is adequately capitalized and managed. The Interstate Banking Act also provides for interstate mergers involving an out-of-state bank's acquisition of a branch of an insured bank without the acquisition of the entire bank, if permitted under the laws of the state where the branch is located. The deposit concentration caps and the -10- minimum age provisions applicable to interstate bank acquisitions also apply to interstate bank mergers. States are permitted, however, to pass legislation either providing for earlier approval of mergers with out-of-state banks or "opting-out" of interstate mergers entirely, provided such legislation applies equally to all out-of-state banks. Texas has passed legislation to "opt out" of interstate mergers entirely until 1999. The Interstate Banking Act also provides for de novo branches in a state if that state expressly elects to permit de novo branching on a non-discriminatory basis. A "de novo branch" is defined as a branch office of a national or state bank that is originally established as a branch and does not become a branch as a result of an acquisition, conversion, merger or consolidation. De novo interstate branching is subject to the same conditions applicable to interstate mergers under the Interstate Banking Act, other than deposit concentration limits. Texas has elected not to permit de novo branching through 1999. The Bank is subject to certain limitations on transactions by and between the Bank and other banks and non-bank companies in the same holding company structure, including limitations on extensions of credit (including guarantees of loans) by the Bank to affiliates, investments in the stock or other securities of the Company by the Bank, and the nature and amount of collateral that the Bank may accept from any affiliate to secure loans extended to the affiliate. The Company, as an affiliate of the Bank, is also subject to these restrictions. Additionally, under the BHC Act and the FRB's regulations, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. National Bank Regulation The Bank is a national banking association and therefore is subject to regulation, supervision and examination by the OCC. The Bank is also a member of the FRB and the FDIC. Requirements and restrictions under the laws of the United States include the requirement that reserves be maintained against deposits, restrictions on the nature and the amount of loans which can be made, restrictions on the business activities in which a bank may engage, restrictions on the payment of dividends to shareholders, and minimum capital requirements. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Capital Resources." As discussed above, the OCC has enforcement authority over the Bank that is similar to that of the FRB with respect to the Company. In addition, upon making certain determinations with respect to the condition of any insured national bank, such as the Bank, the FDIC may begin to terminate a bank's federal deposit insurance. There are certain statutory limitations on the payment of dividends by national banks. Without approval of the OCC, dividends may not be paid in excess of a bank's total net profits for that year, plus its retained profits for the preceding two years, less any required transfers to capital surplus. In addition, a national bank may not pay dividends in excess of total retained profits, including current year's earnings. In some cases, the OCC may find a dividend payment that meets these statutory requirements to be an unsafe or unsound practice. Federal and Texas state laws generally limit the amount of interest and fees which lenders, including the Bank, may charge regarding loans. The applicable law, and the applicable limits, may vary depending upon, among other things, the identity, nature and location of the lender, and the type of loan or collateral. In Texas, the maximum interest rate applicable to most loans changes with changes in the average auction rate for United States Treasury Bills, but does not decline below 18% or rise above 24% (except for certain loans in excess of $250,000 for which the maximum annual rate may not rise above 28%). However, the interest which may be charged on an insurance premium -11- finance loan is regulated by the Texas State Board of Insurance. See "Item 1. Business - Insurance Premium Financing." National banks domiciled in Texas are permitted to engage in unlimited branch banking, subject to the prior approval of the OCC to establish any branch. Banks are affected by the credit policies of other monetary authorities, including the FRB, which affect the national supply of bank credit. Such policies influence overall growth of bank loans, investments, and deposits and may also affect interest rates charged on loans and paid on deposits. The monetary policies of the FRB have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. FDICIA requires the federal bank regulators to take "prompt corrective action" with respect to any depository institution which does not meet specified minimum capital requirements. The applicable regulations establish five capital levels, ranging from "well-capitalized" to "critically undercapitalized," and require or permit the federal bank regulators to take supervisory action regarding any depository institution that is not at least "adequately capitalized." Under these regulations, which became effective December 19, 1992, a depository institution is considered "well capitalized" if it has a total risk-based capital ratio of 10% or greater, a Tier I risk-based capital ratio of 6% or greater, and a leverage ratio of 5% or greater, and it is not subject to an order, written agreement, capital directive or prompt corrective action directive to meet and maintain a specific capital level for any capital measure. A depository institution is considered "adequately capitalized" if it has a total risk-based capital ratio of 8% or greater, a Tier I risk-based capital ratio and leverage ratio of 4% or greater (or a leverage ratio of 3% or greater if the depository institution is rated composite 1 in its most recent report of examination, subject to appropriate federal banking agency guidelines), and the depository institution does not meet the definition of an undercapitalized institution. A depository institution is considered "undercapitalized" if it has a total risk-based capital ratio of less than 8%, a Tier I risk-based capital ratio of less than 4%, or a leverage ratio of less than 4% (or a leverage ratio of less than 3% if the depository institution is rated composite 1 in its most recent report of examination, subject to appropriate federal banking agency guidelines). A "significantly undercapitalized" depository institution is one which has a total risk-based capital ratio of less than 6%, a Tier I risk-based capital ratio of less than 3%, or a leverage ratio of less than 3%. A "critically undercapitalized" depository institution is one which has a ratio of tangible equity to total assets of equal to or less than 2%. With certain exceptions, national banks will be prohibited from making capital distributions or paying management fees if the payment of such distributions or fees will cause them to become undercapitalized. Furthermore, undercapitalized national banks will be required to file capital restoration plans with the OCC. Undercapitalized national banks will also be subject to restrictions on growth, acquisitions, branching and engaging in new lines of business unless they have an approved capital plan that permits otherwise. The OCC also may, among other things, require an undercapitalized national bank to issue shares or obligations, which could be voting stock, to recapitalize the institution or, under certain circumstances, to divest itself of any subsidiary. The OCC is authorized to take various enforcement actions against any significantly undercapitalized national bank and any undercapitalized national bank that fails to submit an acceptable capital restoration plan or fails to implement a plan accepted by the OCC. The powers include, among other things, requiring the institution to be recapitalized, prohibiting asset growth, restricting interest rates paid, requiring prior approval of capital distributions by any bank holding company which controls the institution, requiring divestiture by the institution of its subsidiaries or by the holding company of -12- the institution itself, requiring a new election of directors, and requiring the dismissal of directors and officers. Significantly and critically undercapitalized national banks may be subject to more extensive control and supervision. The OCC may prohibit any such institutions from, among other things, entering into any material transaction not in the ordinary course of business, amending their charters or bylaws, or engaging in certain transactions with affiliates. In addition, critically undercapitalized institutions generally will be prohibited from making payments of principal or interest on outstanding subordinated debt. Within ninety (90) days of a national bank's becoming critically undercapitalized, the OCC must appoint a receiver or conservator unless certain findings are made with respect to the prospect for the institution's continued viability. Based on its capital ratios as of December 31, 1996, the Bank was classified as "well capitalized" under the applicable regulations. The Company does not believe that FDICIA's prompt corrective action regulations will have any material effect on the activities or operations of the Bank. However, if the Bank were to become undercapitalized and these restrictions were to be imposed, the restrictions, either individually or in the aggregate, could have a significant adverse effect on the operations of the Bank, and, as a result, the ability of the Company to pay dividends on the Common Stock or service any cash flow needs. As a result of the enactment of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA"), a depository institution insured by the FDIC, such as the Bank, can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with: (i) the default of a commonly controlled FDIC insured depository institution; or (ii) any assistance provided by the FDIC to a commonly controlled FDIC insured depository institution in danger of default. "Default" is defined generally as the appointment of a conservator or receiver and "in danger of default" if defined generally as the existence of certain conditions indicating that a "default" is likely to occur in the absence of regulatory assistance. Deposit Insurance As an FDIC member institution, the deposits of the Bank are currently insured to a maximum of $100,000 per depositor through the Bank Insurance Fund ("BIF"), administered by the FDIC. Generally, banks are assessed insurance premiums according to how much risk they are deemed to present to BIF. Banks with higher levels of capital and which have earned a low degree of supervisory concern are assessed lower premiums than banks with lower levels of capital or a higher degree of supervisory concern. Under the rate structure which went into effect in January 1996, assessments range from zero to 27 cents per $100 of domestic deposits, subject to a minimum assessment of $2,000. Under this structure, the Bank in 1996 was assessed at a zero rate and paid the minimum assessment rate of $2,000. In November of 1996 the FDIC's Board of Directors voted to retain the existing BIF assessment schedule for 1997, but eliminated the minimum assessment amount, and approved an assessment against BIF-assessable deposits to be paid to the Financing Corporation ("FICO") to assist in paying interest on FICO bonds, which financed the resolution of the thrift industry series. The FICO assessment is approximately 1.3 basis points on BIF-insured deposits. The first quarter 1997 FICO assessment of the Bank is approximately $4,800. Internal Operating Requirements FDICIA contains numerous other provisions, including new accounting, auditing and reporting requirements, the termination (beginning in 1995) of the "too big to fail" doctrine except in special cases, new regulatory standards in areas such as asset quality, earnings and compensation and revised regulatory standards for the powers of state chartered banks, real estate lending, bank closures and capital adequacy. -13- Under the Community Reinvestment Act of 1977 (the "CRA") a bank's applicable regulatory authority (which is the OCC for the Bank) is required to assess the record of each financial institution which it regulates to determine if the institution meets the credit needs of its entire community, including low- and moderate-income neighborhoods served by the institution, and to take that record into account in its evaluation of any application made by such institution for, among other things, approval of the acquisition or establishment of a branch or other deposit facility, an office relocation, a merger, or the acquisition of shares of capital stock of another financial institution. The regulatory authority prepares a written evaluation of an institution's record of meeting the credit needs of its entire community and assigns a rating. The Bank has undertaken significant actions to comply with the CRA, and has received a "satisfactory" commendation in its most recent review by federal regulators with respect to its compliance with the CRA. Both the United States Congress and the banking regulatory authorities have proposed substantial changes to the CRA and fair lending laws, rules and regulations, and there can be no certainty as to the effect, if any, that any such changes would have on the Bank. Capital Adequacy Guidelines Capital management consists of providing equity to support both current and future operations. The Company is subject to capital adequacy requirements issued by the FRB, and the Bank is subject to similar requirements imposed by the OCC. Specifically, the various federal bank regulatory agencies, including the FRB and the OCC, have adopted risk-based capital requirements for assessing bank holding company and bank capital adequacy. These standards define capital and establish minimum capital requirements in relation to assets and off-balance sheet exposure, adjusted for credit risk. The risk-based capital standards currently in effect are designed to make regulatory capital requirements more sensitive to differences in risk profile among bank holding companies and banks, to account for off-balance sheet exposure and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to broad risk categories, each with appropriate relative risk weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items. The minimum standard for the ratio of capital to risk-weighted assets (including certain offbalance sheet obligations, such as standby letters of credit) is 8%. At least half of the risk-based capital must consist of common equity, retained earnings, and qualifying perpetual preferred stock, less deductions for goodwill and various other intangibles ("Tier I capital"). The remainder may consist of a limited amount of subordinated debt, certain hybrid capital instruments and other debt securities, preferred stock, and a limited amount of the general valuation allowance for credit losses ("Tier II capital"). The sum of Tier I capital and Tier II capital is "total risk-based capital." The FRB (for the Company) and the OCC (for the Bank) have also adopted guidelines which supplement the risk-based capital guidelines with a minimum leverage ratio of Tier I capital to average total consolidated assets ("leverage ratio") of 3% for institutions with well diversified risk (including no undue interest rate exposure; excellent asset quality; high liquidity; good earnings); that are generally considered to be strong banking organizations (rated composite 1 under applicable federal guidelines); and that are not experiencing or anticipating significant growth. Other banking organizations are required to maintain a leverage ratio of at least 4% to 5%. These rules further provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain capital positions substantially above the minimum supervisory levels and comparable to peer group averages, without significant reliance on intangible assets. The FRB continues to consider a "tangible Tier I leverage ratio" in evaluating proposals for expanding activities by bank holding companies. The -14- tangible Tier I leverage ratio is the ratio of a banking organization's Tier I capital (less deductions for intangibles otherwise includable in Tier I capital) to total tangible assets. As of December 31, 1996, the Company's Tier I risk-based capital ratio was 11.10%, its total risk-based capital ratio was 12.29% and its leverage ratio was 7.02%, which equaled or exceeded the federal minimum regulatory requirements. Bank regulators may raise capital requirements applicable to banking organizations beyond current levels. However, the Company is unable to predict whether higher capital requirements will be imposed and, if so, at what levels and on what schedules, and therefore cannot predict what effect such higher requirements may have on the Company and the Bank. For an analysis of the Company's and the Bank's capital, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Capital Resources." ITEM 2. PROPERTIES. The Bank has eight banking facilities. The Bank's main office is located in Hurst, Texas, and its branches are located in Chester, Kennard, Lufkin, Midlothian, Waxahachie, Wells and Whitesboro, Texas. The Hurst banking facility is located at 1845 Precinct Line Road, Suite 100, Hurst, Texas 76054. The Company and a branch of the Bank occupy approximately 13,000 square feet of leased space in a two-story building under a lease dated February 14, 1994 for a term of five years and ten months beginning March 1, 1994 and ending on December 31, 1999. The Bank is on a graduated lease payment schedule as follows: Period Monthly Rent ------ ------------ 01-01-97 to 12-31-98 $10,922.37 01-01-99 to 12-31-99 $11,391.36 The Company also occupies a portion of the office space leased by the Bank under this lease. The Chester facility is located in a two-story building on U.S. Highway 287 in Chester, Texas. This building, and the underlying tract of land consisting of approximately 15,000 square feet, are owned by the Bank. The building includes approximately 5,600 square feet of office space. The Bank also owns an improved tract of land (containing approximately 3,000 square feet) located adjacent to the Chester facility. The Kennard facility is located in a one-story building at Broadway and Main Streets in Kennard, Texas. This building, and the underlying tract of land consisting of approximately 14,000 square feet, are owned by the Bank. The building includes approximately 2,790 square feet of office space. The Bank also owns two storage buildings located on the same tract of land. The Lufkin facility is a two-story building located at 600 South First Street in Lufkin, Texas. This building and the underlying tract of land are owned by the Bank. The building includes approximately 10,000 square feet of office space. A detached motor bank facility is also located on the land. -15- The Midlothian facility is located in a one and one-half story building at 910 North 9th Street in Midlothian, Texas. This building, and the underlying tract of land consisting of approximately 71,330 square feet are owned by the Bank. The building includes approximately 17,116 square feet of office space. The Waxahachie facility is located in a two-story building at 104 Elm Street in Waxahachie, Texas. This building, and the underlying tract of land consisting of approximately 14,100 square feet, are owned by the Bank. The building includes approximately 5,100 square feet of office space. The Wells facility is located in a one-story building on U.S. Highway 69 in Wells, Texas. This building, and the underlying tract of land consisting of approximately 9,000 square feet, are owned by the Bank. The building includes approximately 4,500 square feet of office space. The Bank also owns two unimproved tracts of land (one containing approximately 2.31 acres and the other approximately 1,800 square feet) located adjacent to the Wells facility. The Whitesboro facility is located in a one-story building at 2500 Highway 82 East in Whitesboro, Texas. This building, and the underlying tract of land consisting of approximately 132,000 square feet, are owned by the Bank. The building includes approximately 6,400 square feet of office space. The Company believes the existing facilities are adequate for its present needs. ITEM 3. LEGAL PROCEEDINGS. The Bank is a defendant in two related cases: Tennessee Ex Rel. Douglas Sizemore, Commissioner of Commerce and Insurance for the State of Tennessee, et al. vs. Surety Bank, N.A., filed in June 1995 in the Federal District Court for the Northern District of Texas, Dallas, Division (the "Anchorage Case"), and United Shortline Inc. Assurance Services, N.A. et al. vs. MacGregor General Insurance Company, Ltd., et al., now pending in the 141st Judicial District Court of Tarrant County, Texas (the "MacGregor Case"). The claimant in the Anchorage Case is the Tennessee Commissioner of Commerce and Insurance ("Tennessee"), appointed by the Chancery Court for the State of Tennessee, Twentieth Judicial District, Davidson County, to liquidate Anchorage Fire and Casualty Insurance Company ("Anchorage"), including Anchorage deposits at the Bank. Tennessee seeks to recover compensatory and punitive damages on various alleged causes of action, including violation of orders issued by a Tennessee court, fraudulent and preferential transfers, common law conversion, fraud, negligence, and bad faith, all of which are based on the same underlying facts and course of conduct. The plaintiff in the MacGregor Case, United Shortline Inc. Assurance Services, N.A. ("Shortline"), is the holder of a Florida judgment against MacGregor who seeks to recover funds allegedly belonging to MacGregor which were held by the Bank. Both cases arise out of the Bank's alleged exercise of control over funds, representing the Bank's collateral, held in accounts at the Bank under agreements with Anchorage and MacGregor. The Bank asserts that it had a right to exercise control over its collateral under contractual agreements between the Bank and the respective insurance companies or the Bank and the policy holders, and also in order to protect the Bank against the possibility of inconsistent orders regarding the same funds. Tennessee also seeks to recover funds allegedly transferred in and out of the Anchorage/MacGregor accounts at the Bank during an approximate four month period in 1993. -16- When the MacGregor case was initially filed, Shortline sought a restraining order against the Bank concerning the MacGregor funds. When the Bank received notice of competing claims to some or all of these funds by Tennessee, the Bank intervened and interpled approximately $600,000 into the court's registry. Shortline now seeks, inter alia, damages against the Bank from an alleged wrongful offset wherein the Bank allegedly exercised control over the MacGregor funds at the Bank pursuant to agreements with MacGregor. The Bank moved for and obtained a summary judgment that its intervention and interpleader of funds was proper. Shortline also sought and obtained a summary judgment from the trial court that the funds interpled by the Bank into the court's registry belonged to Shortline. Tennessee appealed the summary judgment to the Fort Worth Court of Appeals. The Fort Worth Court of Appeals affirmed the trial court's ruling that the Bank's intervention and interpleader was proper but reversed the trial court's ruling that the funds in the court belonged to Shortline. Currently, Shortline and Tennessee have made application to the Texas Supreme Court to allow an appeal of the ruling from the Fort Worth Court of Appeals. In the Anchorage case, Tennessee claims that the Bank allegedly transferred funds in and out of the Anchorage accounts after allegedly receiving notice of court orders prohibiting such transfers. Discovery in this case is in the initial stages and the damages sought by Tennessee are not yet certain. The Bank believes both of these cases lack merit and intends to defend them vigorously. The outcome of both of these cases is uncertain at this time. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matter was submitted to a vote of the stockholders of the Company during the fourth quarter of 1996. ITEM 4A. EXECUTIVE OFFICERS OF THE CORPORATION. The executive officers of the Corporation, each elected to serve at the pleasure of the Board of Directors until the next annual meeting of the Board of Directors to be held on May 29, 1997, their respective ages, and their present position with the Corporation are as follows:
Position With Position Name Age Corporation Held Since ---- --- ----------- ---------- C. Jack Bean 68 Chairman of the Board and Director March 1987 Bobby W. Hackler 51 Vice Chairman of the Board, Chief January 1997 Operating Officer and Director G. M. Heinzelmann, III 34 President and Director July 1992 B. J. Curley 33 Secretary, Chief Financial Officer and June 1996 Vice President
The business experience of each of these executive officers during the past five (5) years is set forth below: -17- C. Jack Bean has been Chairman of the Board and a director of the Company since March 1987, and served as President of the Company from March 1987 to July 1992. Mr. Bean was the owner and founder of Surety Finance Company, the predecessor company to the Company's business, from 1985 until March 1987. He has served as Chairman of the Board and a director of the Bank since December 1989. Mr. Bean has served as a director of Dallas Fire Insurance Company, a licensed Texas stock insurance company, since November 1996. The president of Dallas Fire Insurance Company is also a director of the Company. Bobby W. Hackler has been Vice Chairman of the Company since February 1997, Chief Operating Officer since June 1996 and a director since May 1994. He previously served as Senior Vice President of the Company from June 1996 to January 1997, as Chief Financial Officer from January 1992 to October 1995, and as Vice President and Secretary from January 1992 to June 1996. He has served as Vice Chairman of the Bank since February 1997, as President since February 1994, as Chief Executive Officer since July 1992, and as a director since December 1990. Mr. Hackler previously served as Chief Operating Officer of the Bank from January 1992 to July 1992. Mr. Hackler has served as a director of McCoy Myers and Associates, Inc., a computer data processing company for banks, since November 1996. The Bank owns a 17% interest in McCoy Myers and Associates, Inc. G. M. Heinzelmann, III has been President of the Company since July 1992 and a director since July 1993. He previously served as Vice President of the Company from May 1987 to July 1992. Mr. Heinzelmann has served as Executive Vice President and a director of the Bank since December 1989 and as Manager of the insurance premium finance division of the Company, and subsequently the Bank, since May 1987. He has also served as Secretary, Treasurer and a director of Brian Capital, Inc., a nonoperating publicly-held corporation, since November 1988. B. J. Curley has been Secretary of the Company since June 1996 and Chief Financial Officer and Vice President since October 1995. Since December 1994 he has served as Chief Financial Officer and Senior Vice President of the Bank and since May 1993 has served as the Bank's Controller. Prior to May 1993 he served as Controller for Environmental Engineering & Geotechnics, Inc. No family relationships exist among the executive officers and directors of the Corporation except as follows: G. M. Heinzelmann, III, President and a director of the Company, is the son-in-law of C. Jack Bean, Chairman of the Board of the Company. Otherwise, there is no family relationship between any of the directors and any executive officer of the Company. -18- PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCK- HOLDER MATTERS. Market Information Since January 10, 1995 the Company's Common Stock has been traded on the American Stock Exchange, Inc.'s ("AMEX") primary list under the symbol "SRY." From February 23, 1994 through January 9, 1995 the Company's Common Stock was traded on the AMEX Emerging Company Marketplace under the symbol "SRY.EC." Prior to February 23, 1994, the Company's Common Stock was traded in the over-the-counter market on the National Association of Securities Dealers Automated Quotation System ("NASDAQ"). The following table sets forth, for the periods indicated, the high, low and close sale price per share of the Company's Common Stock as reported on the AMEX primary list since January 10, 1995, and on the AMEX Emerging Company Marketplace from January 1, 1995 through January 9, 1995. - ---------------------------------------------------------------- High Low Close - ---------------------------------------------------------------- 1995 Fiscal Year First Quarter $4.38 $3.06 $4.13 Second Quarter 6.75 3.19 3.44 Third Quarter 5.13 3.50 4.75 Fourth Quarter 5.00 3.50 3.50 1996 Fiscal Year First Quarter 4.50 3.25 3.75 Second Quarter 4.93 3.63 4.56 Third Quarter 4.93 4.00 4.50 Fourth Quarter 4.88 4.00 4.06 Stockholders As of March 20, 1997 there were 444 record holders of the Company's Common Stock. -19- Quarterly Data (Unaudited)
- ------------------------------------------------------------------------------------------------------------------------------ (dollars in thousands, First Quarter Second Quarter Third Quarter Fourth Quarter Total Year except per share data) to Date - ------------------------------------------------------------------------------------------------------------------------------ 1995 Fiscal Year - ---------------- Interest income $2,210 $2,323 $2,339 $2,663 $9,535 Net interest income 368,292 350,383 338,149 362,243 1,419,067 Income before income taxes 311 273 365 389 1,338 Net Income 210 187 251 239 887 Earnings per share .07 .06 .07 .07 .27 Weighted average shares and share equivalents 3,113,483 3,156,771 3,500,871 3,506,429 3,279,448 1996 Fiscal Year - ---------------- Interest income $2,951 $3,756 $3,769 $3,915 $14,390 Net interest income 397,269 482,843 474,663 522,679 1,877,454 Income before income taxes 363 686 678 875 2,636 Net Income 244 446 443 565 1,698 Earnings per share .06 .08 .08 .10 .32 Weighted average shares and share equivalents 4,319,721 5,746,512 5,746,512 5,747,243 5,389,366 - ------------------------------------------------------------------------------------------------------------------------------
Dividend Policy THE COMPANY. The Company currently intends not to pay dividends for the foreseeable future, but to retain any future earnings for use in the business of the Company and the Bank. The payment of any dividends in the future will be made at the discretion of the Board of Directors of the Company and will depend upon the operating results and financial condition of the Company and the Bank, their capital requirements, contractual agreements, general business conditions and other factors. The Company's principal source of funds to pay dividends in the future, if any, on the Common Stock will be cash dividends the Company receives from the Bank. See "Item 1. Business - Supervision and Regulation" for a discussion of regulatory constraints on the payment of dividends by national banks and bank holding companies generally. THE BANK. The Bank is subject to various restrictions imposed by the National Bank Act relating to the declaration and payment of dividends. The board of directors of a national banking association may, subject to the following limitations, declare a quarterly, semiannual or annual dividend of as much of its net profits as it may judge expedient. The payment of dividends is subject to the provisions of 12 U.S.C. 60, which provides that no dividends may be declared or paid without the approval of the OCC if the total of all dividends, including the proposed dividend, in any calendar year exceeds the total of the national banking association's net profits for that year combined with its retained net profits of the preceding two years. Under the provisions of 12 U.S.C. 56 no dividends may ever be paid in an amount greater than the bank's net profits. The OCC also has authority to prohibit a national bank from engaging in what in the OCC's opinion constitutes an unsafe or unsound practice in conducting business, including the payment of a dividend. See "Item 1. Business - - Supervision and Regulation" for a discussion of regulatory constraints on the payment of dividends by national banks and bank holding companies generally. -20- ITEM 6. SELECTED FINANCIAL DATA. The following summary consolidated financial data of the Company is derived from the financial statements of the Company as of and for the five years ended December 31, 1996. The following summary consolidated financial data of the Company should be read in connection with the consolidated financial statements of the Company and the notes thereto and the information in Management's Discussion and Analysis of Financial Condition and Results of Operations.
Years Ended December 31, ----------------------------------------------------------- 1996(1) 1995(2) 1994(3) 1993(4) 1992 ------- ------- ------- ------- ---- Income Statement Data: ($ in 000's) Interest income $14,390 $9,535 $5,387 $3,995 $3,344 Interest expense 5,362 3,678 1,488 1,124 978 Net interest income 9,028 5,857 3,899 2,871 2,366 Provision for credit losses 135 60 107 91 300 Net interest income after provision for credit losses 8,893 5,797 3,792 2,781 2,067 Noninterest income 1,877 1,419 1,160 1,182 784 Noninterest expense 8,135 5,878 4,462 3,592 2,835 Earnings before income taxes 2,636 1,338 490 371 16 Income taxes 938 451 17 Net earnings (loss) $ 1,698 $ 887 $ 473 $ 371 $ 16 Common Share Data:(5) Net earnings (loss) $ 0.32 $ 0.27 $ 0.20 $ 0.19 $ 0.00 Book value 3.34 2.94 2.65 2.32 2.05 Weighted average common shares outstanding (in 000's) 5,389 3,279 2,394 2,002 1,952 Period end shares outstanding (in 000's) 5,748 3,506 3,041 2,273 1,981 Balance Sheet Data: ($ in 000's) Total assets $176,439 $121,339 $102,294 $49,036 $30,964 Insurance premium finance loans, net 38,224 21,905 20,497 14,209 7,051 Other loans, net 64,935 45,197 44,167 17,417 12,442 Allowance for credit losses 1,285 703 698 401 325 Total deposits 155,690 109,599 92,027 43,596 26,840 Shareholders' equity 19,231 10,295 8,066 5,281 4,058 Performance Data Return (loss) on average total assets 1.0% .8% .8% .8% .1% Return (loss) on average shareholders' equity 9.8 9.5 7.4 8.7 .4 Net interest margin 6.2 6.1 7.1 7.0 8.7 Loans to deposits 65.4 60.6 70.3 72.5 72.6 Asset Quality Ratios Nonperforming assets to total assets .6% .1% .2% .3% .7% Nonperforming loans to total loans .2 .1 .2 .3 .8 Net loan charge-offs to average loans .2 .1 .4 .3 1.6 Allowance for credit losses to total loans 1.2 1.0 1.1 1.3 1.7 Allowance for credit losses to nonperforming loans 502.5 996.1 574.8 425.8 201.1 Capital Ratios Tier I risk-based capital 11.10% 10.76% 10.13% 11.37% 14.44% Total risk-based capital 12.29 11.72 11.17 12.57 15.69 Leverage 7.0 6.9 5.6 10.0 11.9
-21- (1) On February 29, 1996 the Company acquired 100% of the outstanding common stock of First Midlothian Corporation, Midlothian, Texas and on March 15, 1996 the Bank completed the acquisition of certain assets and the assumption of certain liabilities relating to Providers Funding Corporation located in Dallas, Texas. (2) On September 28, 1995 the Company completed the acquisition of certain assets and the assumption of certain liabilities relating to the branch of Bank One, Texas, National Association located in Waxahachie, Texas. (3) On May 31, 1994 the Company acquired 100% of the outstanding common stock of The Farmers Guaranty State Bank of Kennard, Kennard, Texas, and on December 8, 1994 the Company acquired 100% of the outstanding common stock of First National Bank, Whitesboro, Texas. (4) On March 23, 1993 the Company acquired 100% of the outstanding common stock of the Bank of East Texas, Chester, Texas and First State Bank, Wells, Texas. Operations of these two banks have been included in consolidated operations subsequent to February 28, 1993. (5) The information provided for 1992 has been restated to reflect a one-for-ten reverse stock split in June 1993. -22- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. GENERAL The information presented below reflects the lending and related funding business of the Company.
Year Year Year Ended Ended Ended 12/31/96 12/31/95 12/31/94 -------- -------- -------- INSURANCE PREMIUM FINANCING: Average Balance Outstanding $ 29,210,848 $ 23,532,953 $ 19,370,887 Average Yield 12.2% 11.6% 11.2% Interest Income $ 3,563,467 $ 2,739,060 $ 2,172,038 CONSUMER, COMMERCIAL AND REAL ESTATE FINANCING: Average Balance Outstanding Average $ 55,708,207 $ 44,351,305 $ 20,766,039 Yield 12.9% 11.0% 12.0% Interest Income $ 7,216,254 $ 4,862,756 $ 2,482,099 COST OF FUNDS: Average Balance of Deposits $145,572,001 $ 96,198,295 $ 54,458,467 Average Interest Rate 3.7% 3.7% 2.7% Interest Expense $ 5,361,689 $ 3,554,900 $ 1,476,656 COST OF SHORT TERM DEBT: Average Balance of Debt $ 60,108 $ 1,114,355 $ 146,756 Average Interest Rate 11.0% 11.0% 9.5% Interest Expense $ 6,612 $ 122,579 $ 13,914
Note: Average balances are computed using daily balances throughout each period. The following discussion highlights the major changes affecting the operations and financial condition of the Company for the three years ended December 31, 1996. The discussion should be read in conjunction with the consolidated financial statements and accompanying notes included in this report. The Company derives substantially all of its revenues and income from the operation of its subsidiary, the Bank, which provides a full range of commercial and consumer banking services to businesses and individuals in the north and east Texas area. As of December 31, 1996 the Company had total assets of $176,439,310, net loans of $101,866,914, total deposits of $155,690,341, and total shareholders' equity of $19,230,552. The Company reported net income of $1,697,987 for the year ended December 31, 1996 compared with net income of $886,886 for the year ended December 31, 1995 as a result of internal loan growth within its niche products of insurance premium financing and insurance medical claims factoring, and its acquisition of a community bank and a factoring company. On May 31, 1994 the Bank acquired The Farmers Guaranty State Bank of Kennard, Texas. On December 8, 1994 the Bank acquired First National Bank, Whitesboro, Texas and on September 28, 1995 the Bank acquired the assets and assumed the liabilities of the Waxahachie, Texas branch of Bank One, Texas, National Association. On February 29, 1996 the Company acquired First Midlothian Corporation and its wholly-owned subsidiary, First National Bank. These banking facilities are all operated -23- as branches of the Bank. In addition, on March 15, 1996 the Bank acquired certain assets and assumed certain liabilities of Providers Funding Corporation. The Company views these acquisitions as a means of expanding its operations and anticipates they will contribute favorably to future results of the Company. The Company continues to actively serve the banking needs of these local communities, as it has served the local communities of its other branches. The deposits at these new branches will allow the Company to increase its niche lending activities of insurance premium financing and insurance medical claims factoring. The Company's strategy is to continue to acquire community banks with low loan-to-deposit ratios and to use excess deposits to fund insurance premium financing and other niche lending products. See "Item 1. Business - Acquisitions." RESULTS OF OPERATIONS Net Earnings Net earnings were $1,697,987 ($0.32 per share) for the year ended December 31, 1996, compared with net earnings of $886,886 ($0.27 per share) for the year ended December 31, 1995, an increase of $811,101 or 91.4%. Factors contributing to the increase in earnings in 1996 compared with 1995 include an increase in net interest income, growth in the Company's niche lending products, and growth of noninterest income mainly as a result of the acquisition of First Midlothian Corporation, Midlothian, Texas and the acquisition of Providers Funding Corporation. See "Item 1. Business Acquisitions." Net earnings were $886,886 for 1995 ($0.27 per share), compared with net earnings of $472,760 for 1994 ($0.20 per share). The 87.6% increase in earnings in 1995, compared with 1994, was attributable to an increase in net interest income resulting from improved asset quality, growth in the Company's niche lending products and acquisitions of community banks. Earnings Before Income Taxes Earnings before income taxes were $2,636,115 for the year ended December 31, 1996, compared with $1,337,817 for the year ended December 31, 1995, an increase of $1,264,472 or 94.5%. Earnings before income taxes were $1,337,817 for the year ended December 31, 1995, compared with $490,448 for the year ended December 31, 1994, an increase of $847,369 or 173%. During 1994 the Company had no effective tax rate through the utilization of its net operating losses. The Company returned to paying federal income taxes at the effective rate of 32% during 1995, compared with a nominal effective tax rate for 1994. As a result, the net income for the years ended December 31, 1996 and 1995 may be more indicative of operating trends in the future. Conversely, earnings before income taxes in the 1994 period may be more useful when comparing results with prior periods. Net Interest Income Net interest income is the difference between income earned on interest-earning assets and the interest expense incurred on interest-bearing liabilities. The net yield on total interest-earning assets, also referred to as interest rate margin or net interest margin, represents net interest income divided by average interest-earning assets. The Company's principal interest-earning assets are loans, investment securities, medical receivables factoring and federal funds sold. Net interest income was $8.9 million for the year ended December 31, 1996, an increase of $3.1 million or 53.4% compared with the year ended December 31, 1995, resulting principally from an -24- increase in average interest-earning assets from $96.3 million to $145.9 million, a significant portion of which was comprised of loans (typically the highest yielding asset). The increase in average interest-earning assets was offset by an increase in average interest-bearing liabilities from $84.4 million to $125.5 million. In addition, the Company experienced an increase in the net interest spread of 10 basis points from 6.1% to 6.2% for the years ended December 31, 1995 and 1996, respectively. The foregoing increase resulted principally from the fact that the cost of interest-bearing liabilities decreased by 10 basis points while the yield on interest-earning assets remained unchanged at 9.9% for 1996 and 1995. Net interest income was $5.8 million for 1995, an increase of $2.0 million or 52.6% compared with net interest income of $3.8 million for 1994, which represented an increase of $1 million or 35.8% compared with net interest income of $2.8 million for 1993. The Company's average total interest-earning assets increased from approximately $54.8 million for 1994 to $96.3 million for 1995, representing a 75.7% increase resulting principally from an increase in loans. The net interest margin of 6.1% for 1995 decreased 100 basis points from 7.1% for 1994 and is attributed to the decrease in the average loan to deposit ratio in 1995. The average loan to deposit ratio for 1995 was 69.7% as compared to 73.8% for 1994. The Company's average total interest-earning assets increased from $41.2 million for 1993 to $54.8 million for 1994, representing a 33.1% increase resulting principally from an increase in loans and investment securities. The Company's net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as a "volume change." It is also affected by changes in yields earned on interest-earning assets and rates paid on interest-bearing deposits and other borrowed funds, referred to as a "rate change." The net yield on total interest-earning assets from 1995 to 1996 remained unchanged at 9.9% and resulted principally from an increase in the average yield on all loan products. The yield on the investment portfolio and federal funds sold decreased from 1995 to 1996 as a result of changes in interest rates within the marketplace. The yield on loans increased to 12.1% for the year ended December 31, 1996 from 11.2% for the year ended December 31, 1995. The cost of interest-bearing liabilities decreased to 4.3% for the year ended December 31, 1996 from 4.4% for the year ended December 31, 1995. The following table sets forth for each category of interest-earning assets and interest-bearing liabilities the average amounts outstanding, the interest earned or paid on such amounts and the average rate paid for the three years ended December 31, 1996, 1995 and 1994. The table also sets forth the average rate earned on all interest-earning assets, the average rate paid on all interest-bearing liabilities, and the net yield on average interest-earning assets for the same periods. -25- AVERAGE BALANCE SHEET AND ANALYSIS OF NET INTEREST INCOME
Year ended December 31, 1996 Year ended December 31, 1995 ---------------------------- ---------------------------- Interest Interest Average Income/ Average Average Income/ Average Balance Expense Rate Balance Expense Rate ------- ------- ---- ------- ------- ---- ASSETS Interest-earning assets: Interest-bearing deposits $ 531,688 $ 42,117 7.9% $ 1,388,817 $ 101,408 7.3% U.S. Treasury and agency 38,229,219 2,489,906 6.5 16,659,034 1,173,748 7.1 securities(1) Federal funds sold 19,291,373 1,078,618 5.6 11,102,928 657,809 5.9 Loans (2) (3) 88,985,654 10,779,721 12.1 67,884,258 7,601,816 11.2 Allowance for credit losses (1,162,713) N/A N/A (713,629) N/A N/A ------------ ----------- ---- ---------- --------- --- Total interest-earning assets $145,875,221 $14,390,362 9.9% $96,321,408 $9,534,781 9.9% ------------ ----------- ---- ----------- ---------- --- Cash and due from banks 6,231,693 4,637,833 Premises and equipment 3,806,385 2,495,279 Accrued interest receivable 1,010,323 646,012 Other real estate owned 585,587 77,197 Other assets 6,965,368 3,076,316 --------- ---------- Total assets $164,474,577 $107,254,045 =========== =========== LIABILITIES Interest-bearing liabilities: Interest-bearing demand deposits $36,910,314 $ 880,776 2.4% $23,106,404 $ 678,303 2.9% Savings deposits 8,174,212 176,108 2.1 5,329,462 127,211 2.4 Time deposits 80,397,763 4,298,193 5.3 54,873,148 2,749,386 5.0 Notes payable 60,108 6,612 11.0 1,114,355 122,579 11.0 ------------ ---------- ---- ----------- ----------- ---- Total interest-bearing liabilities $125,542,397 $5,361,689 4.3% $84,423,369 $3,677,479 4.4% ------------ ---------- ---- ----------- ---------- --- Noninterest-bearing deposits 20,089,712 12,889,281 Other liabilities 1,564,827 630,055 ------------ ---------- Total liabilities 147,196,936 97,942,705 Shareholders' equity 17,277,641 9,311,340 ------------ ---------- Total liabilities and equity $164,474,577 $107,254,045 ============ ============ Net interest income $9,028,673 $5,857,302 ========== ========== Net interest spread 5.6% 5.5% === === Net interest margin 6.2% 6.1% === ===
(1) Interest income on tax exempt securities does not reflect the tax equivalent yield. (2) Loans on nonaccrual status have been included in the computation of average balances. (3) The interest income on loans does not include loan fees. Loan fees are immaterial and are included in noninterest income. The following table reflects the changes in net interest income resulting from changes in interest rates and from asset and liability volume, including mix. The change in interest attributable to both rate and volume has been allocated to the changes in rate and volume on a pro rata basis. -26- RATE/VOLUME ANALYSIS OF NET INTEREST INCOME
Years Ended Years Ended December 31, 1996 December 31, 1995 Compared with Compared with December 31, 1995 December 31, 1994 --------------------------------------------- --------------------------------------------- Increase (Decrease) Due to Increase (Decrease) Due to Volume (1) Rate Changes Volume (1) Rate Changes ---------- ---- ------- ---------- ---- ------- Interest Income: Interest-bearing deposits in financial institutions $(68,743) $9,452 $(59,291) $29,607 $3,628 $33,235 U.S. Treasury and Agency Securities 1,397,764 (81,606) 1,316,158 573,825 237,845 811,670 Federal funds sold 455,576 (34,767) 420,809 259,876 95,312 355,188 Loans 2,625,216 552,689 3,177,905 3,112,412 (164,733) 2,947,679 Total interest income $4,409,813 $445,768 $4,855,581 $3,975,720 $172,052 $4,147,772 Interest Expense: Interest-bearing demand deposits $ 294,815 $(92,342) $ 202,473 $ 194,483 $ 224,707 $ 419,190 Savings deposits 59,812 (10,915) 48,897 47,128 (13,927) 33,201 Time deposits 1,353,797 195,010 1,548,807 1,255,544 370,309 1,625,853 Federal funds purchased (115,969) 2 (115,967) 104,267 7,237 111,504 and other borrowed funds Total interest expense $1,592,455 $ 91,755 $1,684,210 $ 1,601,422 $ 588,326 $2,189,748 Net interest margin $2,817,358 $354,013 $3,171,371 $2,374,298 $ (416,274) $1,958,024
(1) Non-accrual loans are included in the average volumes used in calculating this table. Provision for Credit Losses The amount of the provision for credit losses is based on periodic (not less than quarterly) evaluations of the loan portfolio, with particular attention directed toward nonperforming and other potential problem loans. During these evaluations, consideration is given to such factors as: management's evaluation of specific loans; the level and composition of nonperforming loans; historical loss experience; results of examinations by regulatory agencies; an internal asset review process; the market value of collateral; the strength and availability of guaranties; concentrations of credits; and other judgmental factors. The Company determines separate general allowances for insurance premium financing and non-insurance premium financing loans. The Company's loss experience on insurance premium financing lending was adversely affected during the second half of 1991 by the failure of a non-Best rated insurance company. The Company has implemented certain changes in its lending policies and procedures with respect to insurance premium financing lending which have reduced the maximum concentration by insurance carrier except as approved by the Board of Directors and have also reduced the amount of loans secured by unearned premiums of insurance policies written by non-rated carriers. See "Item 1. Business - Insurance Premium Financing." As a result of these changes in loan policy and recoveries of previously charged-off insurance premium financing loans, the Company's historical loss factor on insurance premium finance loans has improved from 0.15% in 1993 to 0.00% in 1994, 1995 and 1996. -27- The Company recorded a $135,000 provision for credit losses during the year ended December 31, 1996 compared with $60,000 in 1995, $106,899 in 1994 and $90,584 in 1993. The 125% increase in the 1996 provision when compared with 1995 was necessitated by the growth in the loan portfolio. The 43.9% decrease in the 1995 provision when compared with 1994 was due to an improvement in the Company's ratio of net charge-offs to average loans improved for this period. Noninterest Income Noninterest income is generated primarily from fees associated with noninterest and interest-bearing accounts as well as fees associated with loans (e.g., late fees). Noninterest income for the year ended December 31, 1996 was $1,877,454, an increase of $458,387 or 32.3% compared with noninterest income of $1,419,067 for the year ended December 31, 1995. The increase in noninterest income is attributed to the acquisition of First Midlothian Corporation and its wholly-owned subsidiary, First National Bank, Midlothian, Texas, during 1996, as well as an increase in loans outstanding. The acquisition of First National Bank increased the number and balance of loans outstanding along with the number and balance of noninterest and interest-bearing deposit accounts, which resulted in increased noninterest income. Noninterest income for the year ended December 31, 1995 was $1,419,067, an increase of $259,060 or 22.3% compared with noninterest income of $1,160,007 for the year ended December 31, 1994. The increase in noninterest income is attributed to the acquisition of the Farmers Guaranty State Bank, Kennard, First National Bank, Whitesboro during 1994, and the Waxahachie branch of Bank One during 1995, as well as an increase in loans outstanding. The acquisition of the three banks increased the number and balance of loans outstanding and increased the number and balance of noninterest and interest-bearing deposit accounts, which resulted in increased noninterest income. The following table sets forth the various categories of noninterest income for the years ended December 31, 1996, 1995 and 1994. NONINTEREST INCOME
Years Ended December 31, ----------------------------------------------------- 1996 1995 1994 ---- ---- ---- Noninterest income Nonsufficient fund charges $460,156 $291,954 $263,315 Late fee charges 681,644 501,960 426,476 Service charges 372,456 220,086 163,336 Collection fees 135,533 115,478 96,162 Credit life insurance 57,509 75,435 44,402 Secured credit card annual fee 4,447 6,561 15,905 Other 165,409 207,593 150,411 ---------- ---------- ---------- Total noninterest income $1,877,454 $1,419,067 $1,160,007 ========== ========== ==========
Noninterest Expense Noninterest expense was $8,135,012 for the year ended December 31, 1996, an increase of $2,256,460 or 38.4% compared with noninterest expense of $5,878,552 for the year ended December 31, 1995. This increase resulted principally from the acquisition of First Midlothian Corporation and its -28- wholly-owned subsidiary, First National Bank, and Providers Funding Corporation. The addition of First National Bank and Providers Funding Corporation resulted in additional personnel, occupancy and office expenses. The amortization of intangibles increased in 1996 as a result of the addition of goodwill and costs in the amount of $106,426 associated with the acquisition of First National Bank and the addition of goodwill and costs in the amount of $58,021 associated with the acquisition of Providers Funding Corporation. Noninterest expense was $5,878,552 for the year ended December 31, 1995, an increase of $1,416,614 or 31.7% compared with noninterest expense of $4,461,938 for the year ended December 31, 1994. This increase resulted principally from the acquisition of The Farmers Guaranty State Bank of Kennard, Kennard, Texas, First National Bank, Whitesboro, Texas during 1994, and the Waxahachie branch of Bank One during 1995. The addition of the three banks resulted in additional personnel, occupancy and office expenses. The amortization of intangibles increased in 1995 as a result of the addition of goodwill and costs associated with the acquisition of The Farmers Guaranty State Bank of Kennard in the amount of $296,164, the addition of goodwill and costs associated with the acquisition of First National Bank in the amount of $1,886,682 and the addition of goodwill and costs associated with the acquisition of the Waxahachie branch of Bank One in the amount of $148,772. Deposits held by the Bank are insured by the Bank Insurance Fund ("BIF") of the Federal Deposit Insurance Corporation ("FDIC"). The FDIC assessment is calculated on the level of deposits held by the Bank. The BIF assessment rate is determined by the FDIC for categories of banks based upon the risk to the insurance fund. On August 8, 1995 the FDIC's Board of Directors voted to significantly reduce the deposit insurance premiums paid by most banks. Under the new rate structure, which became effective September 1995, the best-rated institutions insured by the BIF paid $0.04 per $100 of domestic deposits, down from the rate of $0.23 per $100. Effective January 1996 the FDIC's Board of Directors voted again to reduce the deposit insurance premiums paid by most banks. Under the new rate structure, assessments ranged from zero to 27 cents per $100 of domestic deposits, subject to a minimum annual assessment of $2,000. Under this structure, the Bank in 1996 was assessed at a zero rate and paid the minimum assessment rate of $2,000. In November of 1996 the FDIC's Board of Directors voted to retain the existing BIF assessment schedule for 1997, but eliminated the minimum assessment amount, and approved an assessment against BIF-assessable deposits to be paid to the Financing Corporation ("FICO") to assist in paying interest on FICO bonds, which financed the resolution of the thrift industry series. The FICO assessment is approximately 1.3 basis points on BIF-insured deposits. The first quarter 1997 FICO assessment of the Bank is approximately $4,800. See "Item 1. Business - Supervision and Regulation." -29- NONINTEREST EXPENSE
Years ended December 31, ----------------------------------------------------- 1996 1995 1994 ----- ----- ---- Salaries and employee benefits $4,244,874 $2,923,118 $2,201,188 Occupancy and equipment 1,244,551 907,286 669,936 General and administrative expense: Professional fees 467,662 416,006 315,434 Office supplies 386,114 253,542 201,028 Travel and entertainment 96,577 68,987 60,162 Telephone 283,564 166,858 128,407 Advertising 174,335 104,499 54,683 Postage 299,388 230,807 133,887 Amortization of intangibles 359,717 184,332 51,201 Dues and subscriptions 70,559 49,331 54,609 Insurance 167,245 130,335 97,473 Credit cards 7,472 19,868 59,573 Bank service charge 110,881 57,196 25,808 FDIC assessment 3,553 123,310 133,112 Credit reports 22,850 40,105 17,714 Other 195,670 202,972 257,723 Total general and administrative 2,645,587 2,048,148 1,590,814 Total noninterest expense $8,135,012 $5,878,552 $4,461,938
Income Taxes The Company and the Bank will file a consolidated tax return for 1996. The Company estimates that its effective tax rate for 1996 will be approximately 35% and has recognized income tax expense of $938,128 on income before taxes of $2,636,115 for the year ended December 31, 1996 as compared with income tax expense of $450,931 on income before taxes of $1,337,817 for the year ended December 31, 1995. Interest Rate Sensitivity Management The operating income and net income of the Bank depend, to a substantial extent, on "rate differentials", i.e., the differences between the income the Bank receives from loans, securities and other earning assets, and the interest expense it pays to obtain deposits and other liabilities. These rates are highly sensitive to many factors which are beyond the control of the Bank, including general economic conditions and the policies of various governmental and regulatory authorities. -30- The objective of monitoring and managing the interest rate risk position of the balance sheet is to contribute to earnings and to minimize the adverse changes in net interest income. The potential for earnings to be affected by changes in interest rates is inherent in a financial institution. Interest rate sensitivity is the relationship between changes in market interest rates and changes in net interest income due to the repricing characteristics of assets and liabilities. An asset sensitive position in a given period will result in more assets being subject to repricing; therefore, as interest rates rise, such a position will have a positive effect on net interest income. Conversely, in a liability sensitive position, where liabilities reprice more quickly than assets in a given period, a rise in interest rates will have an adverse effect on net interest income. One way to analyze interest rate risk is to evaluate the balance of the interest rate sensitivity position. A mix of assets and liabilities that are roughly equal in volume and term and repricing represents a matched interest rate sensitivity position. Any excess of assets or liabilities in a particular period results in an interest rate sensitivity gap. The following table presents the interest rate sensitivity for the Company's interest-earning assets and interest-bearing liabilities at December 31, 1996: -31- INTEREST-RATE SENSITIVE ASSETS AND LIABILITIES
3 months 6 months 1 year 3 months to to to Over or less 6 months 1 year 5 years 5 years Total ------------ ------------ ------------ ------------ ------------ ------------ Interest-earning assets: Interest-earning deposits in financial institutions $ 95,265 $ 95,577 $ 95,000 $ 285,842 Investment securities 3,221,113 2,017,285 $ 5,146,741 18,714,657 $ 9,682,747 38,782,543 Federal funds sold 16,772,000 16,772,000 Loans 41,641,731 20,446,883 16,949,696 19,063,757 5,049,621 103,151,688 ------------ ------------ ------------ ------------ ------------ ------------ Interest-earning assets $ 61,730,109 $ 22,559,745 $ 22,096,437 $ 37,873,414 $ 14,732,368 $158,992,073 ------------ ------------ ------------ ------------ ------------ ------------ Interest-bearing liabilities: Interest-bearing demand deposits $ 40,874,278 $ 40,874,278 Savings deposits 7,493,087 7,493,087 Time deposits 27,123,281 $ 16,076,329 $ 31,946,685 $ 8,297,937 83,444,232 ------------ ------------ ------------ ------------ ------------ ------------ Interest-bearing liabilities $ 75,490,646 $ 16,076,329 $ 31,946,685 $ 8,297,937 $131,811,597 ------------ ------------ ------------ ------------ ------------ ------------ Period interest sensitivity gap $(13,760,537) $ 6,483,416 $ (9,850,248) $ 29,575,477 $ 14,732,368 $ 27,180,476 ============ ============ ============ ============ ============ ============ Cumulative interest sensitivity gap $(13,760,537) $ (7,277,121) $(17,127,369) $ 12,448,108 $ 27,180,476 $ 27,180,476 ============ ============ ============ ============ ============ ============ Cumulative gap as a percent of total assets (7.8)% (4.1)% (9.7)% 7.0% 15.4% 15.4% Cumulative interest- sensitive assets as percent of cumulative interest-sensitive 81.8% 92.1% 86.1% 109.4% 120.6% 120.6% liabilities
The cumulative rate-sensitive gap position at one year was a liability-sensitive position of $17.9 million, or negative 10.1%. A closer examination of the investment securities reveals that the call options on securities within the portfolio that are expected to be exercised will change the cumulative rate-sensitive gap position at one year to a liability-sensitive position of $8.3 million, or negative 4.7%, which indicates that the Company is currently in a closely matched interest rate-sensitive position. Accordingly, the Company believes it will not experience a significant impact from changes in interest rates. The Company undertakes this interest rate-sensitivity analysis to monitor the potential risk to future earnings from the impact of possible future changes in interest rates on currently existing net assets or net liability positions. However, this type of analysis is as of a point-in-time, when in fact the Company's interest rate sensitivity can quickly change as market conditions, customer needs, and management strategies change. Thus, interest rate changes do not affect all categories of assets and liabilities equally or at the same time. The Company's investment policy does not permit the purchase of derivative financial instruments or structured notes. -32- The preceding table does not necessarily indicate the impact of general interest rate movements on the Company's net interest income because the repricing of certain assets and liabilities is discretionary and is subject to competitive and other pressures. Currently, the Bank is holding $536,340 in mortgage-backed securities. Although the mortgage-backed securities have a stated maturity greater than five years, it is not uncommon for mortgage-backed securities to fully pay down well ahead of stated maturities. As a result, assets and liabilities indicated as repricing within the same period may, in fact, reprice at different times and at different rate levels. ANALYSIS OF FINANCIAL CONDITION Loans and Asset Quality The Company's loans are diversified by borrower and industry group. Loan growth has occurred every year over the past five years and can be attributed to acquisitions, increased loan demand and the addition of new lending products. The following table describes the composition of loans by major categories outstanding at December 31, 1996, 1995, 1994, 1993 and 1992: LOAN PORTFOLIO ANALYSIS
December 31, ----------------------------------------------------------------------------------------- 1996 1995 1994 1993 1992 ----------------------------------------------------------------------------------------- Aggregate Principal Amount -------------------------- Loans, net of unearned interest: Insurance premium financing $ 39,168,604 $22,409,356 $20,931,642 $14,518,680 $ 7,267,889 Commercial loans 22,745,139 16,301,840 13,205,698 5,204,120 4,142,926 Installment loans 12,631,520 10,645,406 12,029,243 9,016,179 7,386,598 Real estate loans 24,774,167 16,281,558 17,297,636 1,878,030 809,215 Medical claims receivable 6,377,061 3,353,540 2,705,974 2,379,482 1,094,461 ------------- ------------ ------------ ------------ ----------- Total loans 105,696,491 68,991,700 66,170,193 32,996,491 20,701,089 Less: Unearned interest (2,544,803) (1,889,461) (1,506,843) (1,370,229) (1,207,469) Allowance for credit losses (1,284,774) (702,927) (697,948) (401,227) (324,728) ------------- ------------ ------------ ------------- ----------- Total net loans $101,866,914 $66,399,312 $63,965,402 $31,225,035 $19,168,892 ============ =========== =========== =========== =========== Percentage of Loan Portfolio ---------------------------- Loans, net of unearned interest: Insurance premium financing 37.1% 32.5% 31.6% 44.0% 35.1% Commercial loans 21.5 23.6 19.6 15.8 20.0 Installment loans 11.9 15.4 18.2 27.3 35.7 Real estate loans 23.4 23.6 26.1 5.7 3.9 Medical claims receivable 6.1 4.9 4.5 7.2 5.3 ------ -------- ------- -------- -------- Total 100.0% 100.0% 100.0% 100.0% 100.0% ======= ======== ======== ======== ========
The concentration of insurance premium financing loans may expose the Bank to greater risk of loss than would a more diversified loan portfolio. -33- As of December 31, 1996 and 1995 commitments of the Bank under standby letters of credit and unused lines of credit totaled approximately $3,976,000 and $3,698,000, respectively. Stated loan maturities (including floating rate loans reset to market interest rates) of the total loan portfolio, net of unearned income, as of December 31, 1996 were: STATED LOAN MATURITIES
One Within Year to After One Five Five Year Years Years Total ---- ----- ----- ----- Stated Loan Maturities/Floating Rates Reset: Insurance premium financing $ 38,782,543 $ 38,224,213 Commercial and real estate loans 34,480,091 $19,063,757 $ 5,049,621 58,593,469 Medical claims receivable 6,334,006 6,334,006 ----------- ----------- ----------- ----------- Total $ 79,596,640 $19,063,757 $ 5,049,621 $103,151,688 =========== ========== ========== -----------
Rate sensitivities of the total loan portfolio before unearned income as of December 31, 1996 were as follows: LOAN REPRICING
One Year After Within to Five Five One Year Years Years Total -------- ----- ----- ----- Fixed Rate $ 54,623,671 $ 18,259,465 $ 5,049,621 $ 77,932,757 Variable Rate 24,405,104 669,971 25,075,075 Non Accrual 9,535 134,321 143,856 ------------- ------------ ----------- ------------ Total $ 79,038,310 $ 19,063,757 $ 5,049,621 $ 103,151,688 ============ ============ ========== ============
The maturities presented above are based upon contractual maturities. Many of these loans are made on a short-term basis with the possibility of renewal at time of maturity. All loans, however, are reviewed on a continuous basis for creditworthiness. Nonperforming Assets The Company's financial statements are prepared on the accrual basis of accounting, including the recognition of interest income on its loan portfolio, unless a loan is placed on a nonaccrual basis. Loans are placed on a nonaccrual basis when there are serious doubts regarding the complete collectibility of principal and interest. Amounts received on nonaccrual loans generally are applied first to principal and then to interest after all principal has been collected. Troubled debt restructurings are those for which concessions, including reduction of interest rates or deferral of interest or principal, have been granted, due to a borrowers weakened financial condition. Interest on restructured loans is accrued at the restructured rates when it is anticipated that no loss of original principal will occur. It is the policy of the Bank not to renegotiate the terms of a loan simply because of a delinquent status. Rather, a loan is generally transferred to a nonaccrual status if it is not in the process of collection and is delinquent in payment of either principal or interest beyond 90 days. Loans which are 90 days -34- delinquent but are well secured and in the process of collection are not included in nonperforming assets. Other nonperforming assets consist of real estate acquired through loan foreclosures or other workout situations and other assets acquired through repossessions. The following table summarizes nonperforming assets by category as of December 31, 1996 and 1995: NONPERFORMING ASSETS
1996 1995 ---- ---- Nonaccrual loans $ 143,856 $ 31,000 Loans 90 days past due and still 111,797 39,568 -------- --------- accruing interest Total nonperforming loans 255,653 70,568 Other real estate owned and other assets 738,198 85,528 --------- -------- Total nonperforming assets $993,851 $156,096 ======= ======= Nonperforming assets to total assets 0.6% 0.1% Nonperforming loans to total loans 0.2% 0.1%
The classification of a loan on nonaccrual status does not necessarily indicate that the principal is uncollectible, in whole or in part. A determination as to collectibility is made by the Bank on a case-by-case basis. The Bank considers both the adequacy of the collateral and the other resources of the borrower in determining the steps to be taken to collect nonaccrual loans. The final determination as to these steps is made on a case-by-case basis. Alternatives that are considered are foreclosure, collecting on guarantees, restructuring the loan or collection lawsuits. The following table sets forth a summary of other real estate owned and other collateral acquired as of December 31, 1996: OTHER REAL ESTATE OWNED & OTHER COLLATERAL ACQUIRED Number of Net Book Description Parcels/Autos Carrying Value - --------------------------------------------------------------------- Vacant land or unsold lots 8 $571,428 Repossessed automobiles 29 $166,770 -------- $738,198 Allowance for Credit Losses In originating loans, the Company recognizes that credit losses will be experienced and the risk of loss will vary with, among other things, general economic conditions, the type of loan being made, the creditworthiness of the borrower over the term of the loan and, in the case of a collaterialized loan, the quality of the collateral for such loan. The allowance for credit losses represents the Company's estimate of the allowance necessary to provide for losses incurred in the loan portfolio. In making this determination, the Company analyzes the ultimate collectibility of the Company's loan portfolio, incorporating feedback provided by the internal loan review staff and provided by examinations -35- performed by regulatory agencies. The Company makes an ongoing evaluation as to the adequacy of the allowance for credit losses. To establish the appropriate level of the allowance, all loans (including nonperforming loans), commitments to extend credit and standby letters of credit are reviewed and classified as to potential loss exposure. Specific allowances are then established for those loans, commitments to extend credit or standby letters of credit with identified loss exposure and an additional allowance is maintained based upon the size, quality, and concentration characteristics of the remaining loan portfolio using both historical quantitative trends and the Company's evaluation of qualitative factors including future economic and industry outlooks. The determination by the Company of the appropriate level of allowance amount was $1,284,774, at December 31, 1996. The allowance for credit losses is based on estimates, and ultimate losses will vary from current estimates. These estimates are reviewed monthly and as adjustments, either positive or negative, become necessary they are reported in earnings in the periods in which they become known. The following table presents a detailed analysis of the Company's allowance for credit losses for the year ended December 31, 1996 and for the years ended December 31, 1995, 1994, 1993 and 1992: -36- ALLOWANCE FOR CREDIT LOSSES
December 31, ------------ 1996 1995 1994 1993 1992 ------------- ------------- ------------- ------------- ------------- Beginning balance $ 702,927 $ 697,948 $ 401,227 $ 324,728 $ 343,206 ------------- ------------- ------------- ------------- ------------- Charge-offs: Commercial loans (18,875) (13,151) (41,537) (48,681) (202,777) Installment loans (188,419) (104,295) (163,669) (179,713) (287,113) Real estate loans (21,185) (5,350) Insurance premium finance (939) (1,710) (19,380) (182,423) ------------- ------------- ------------- ------------- ------------- Total charge-offs (229,418) (117,446) (212,266) (247,774) (672,313) ------------- ------------- ------------- ------------- ------------- Recoveries: Commercial loans 5,067 1,012 15,698 1,412 30,081 Installment loans 43,538 37,366 43,070 88,511 89,005 Real estate loans 10,240 13,288 Insurance premium finance 2,720 2,488 71,790 235,194 ------------- ------------- ------------- ------------- ------------- Total recoveries 61,565 51,666 61,256 161,713 354,280 ------------- ------------- ------------- ------------- ------------- Net charge-offs (167,853) (65,780) (151,010) (86,061) (318,033) Bank acquisition 614,700 10,759 340,832 71,976 Provision for credit losses 135,000 60,000 106,899 90,584 299,555 ------------- ------------- ------------- ------------- ------------- Ending balance $ 1,284,744 $ 702,927 $ 697,948 $ 401,227 $ 324,728 ============= ============= ============= ============= ============= Period end total loans, net of $ 103,151,688 $ 67,102,239 $ 64,663,350 $ 31,626,262 $ 19,493,620 ============= ============= ============= ============= ============= unearned interest Average loans $ 88,985,654 $ 67,884,258 $ 40,136,926 $ 26,008,833 $ 20,496,380 ============= ============= ============= ============= ============= Ratio of net charge-offs to average 0.2% 0.1% 0.4% 0.3% 1.6% ============= ============= ============= ============= ============= loans Ratio of provision for credit losses to average loans 0.1% 0.1% 0.3% 0.3% 1.5% ============= ============= ============= ============= ============= Ratio of allowance for credit losses to ending total loans 1.2% 1.0% 1.1% 1.3% 1.7% ============= ============= ============= ============= ============= Ratio of allowance for credit losses to total nonperforming loans 502.5% 996.1% 574.8% 425.8% 201.1% ============= ============= ============= ============= ============= Ratio of allowance for credit losses to total nonperforming assets 129.3% 450.3% 287.5% 311.2% 148.5% ============= ============= ============= ============= =============
The following table sets forth an allocation of the allowance for credit losses among categories as of December 31, 1996 and 1995. The Company believes that any allocation of the allowance for credit losses into categories lends an appearance of precision which does not exist. The allowance is utilized as a single unallocated allowance available for all loans. The following allocation table should not be interpreted as an indication of the specific amounts or the relative proportion of future charges to the allowance. Such a table is merely a convenient device for assessing the adequacy of the allowance as a whole. The following allocation table has been derived by applying a general allowance to the portfolio as a whole, in addition to specific allowance amounts for internally classified loans. -37- In retrospect, the specific allocation in any particular category may prove excessive or inadequate and consequently may be reallocated in the future to reflect the then current condition. Accordingly, the entire allowance is available to absorb losses in any category. ALLOCATION OF ALLOWANCE FOR CREDIT LOSSES December 31, 1996 December 31, 1995 ------------------- ------------------ Percent of Percent of Allowance Allowance Amount by Category Amount by Category Insurance premium financing loans $ 217,734 17.0% $154,644 22.0% Commercial loans 396,031 30.8% 179,246 25.5% Installment loans 397,353 30.9% 222,828 31.7% Real estate loans 273,656 21.3% 146,209 20.8% ----------- ------ -------- ------ Total $1,284,774 100.0% $702,927 100.0% ========== ====== ======== ====== Investment Activities The investment portfolio, which was 24.6% of the Company's earning asset base as of December 31, 1996, is being managed to minimize interest rate risk, maintain sufficient liquidity and maximize return. Investment securities which are classified as held-to-maturity are purchased with the intent and ability of the Company to hold them to maturity as evidenced by the strong capital position of the Company and short maturity of the portfolio. Securities classified as held-to-maturity are carried at historical cost. The Company's financial planning anticipates income streams based on normal maturity and reinvestment. The short duration of the portfolio provides adequate liquidity through normal maturities. Investment securities classified as available-for-sale are purchased with the intent to provide liquidity and to increase returns. The securities classified as available-for-sale are carried at fair value. The Company does not have any securities classified as trading. As of December 31, 1996, $22.6 million in investment securities were classified as held-tomaturity and $16.2 million were classified as available-for-sale. On February 29, 1996 the Bank's investment portfolio increased by $21.2 million as a result of the acquisition of First National Bank, Midlothian, Texas. The securities added to the investment portfolio through the acquisition increased the size of the investment portfolio by approximately 106%. The securities acquired through the acquisition closely matched the investment objectives of the Bank; therefore, no securities were sold after the acquisition. On December 8, 1994 the Bank's investment portfolio increased by $14.6 million as a result of the acquisition of the bank in Whitesboro. The securities added to the investment portfolio through the acquisition increased the size of the investment portfolio by approximately 301%. This large increase resulted in a need to restructure the investment portfolio in an effort to address capital budgeting needs and to address the Bank's investment objectives. During the first quarter of 1995, $4.7 million in available-for-sale securities were sold for gross realized gains of $100 and no gross recognized losses. As of December 31, 1996 proceeds from the maturity of held-to-maturity securities were $15.5 million and the maturity of available-for-sale securities were $0.9 million. During 1996 purchases of held-to-maturity securities were $3.1 million and purchases of available-for-sale securities were $7.2 million. No securities were sold during 1996. -38- The amortized cost of the held-to-maturity securities was $22.6 million as compared with their estimated market value of $22.8 million on December 31, 1996. The unrealized gain on the held-to-maturity securities was $201,982. The securities within the available-for-sale classification had an amortized cost of $16.2 million and an estimated market value of $16.2 million on December 31, 1996. The unrealized loss in the available-for-sale securities was $22,376 as of December 31, 1996. These unrealized losses are the result of interest rate movements during 1996 and other market forces, and would be realized in part or in whole if some or all of the available-for-sale securities were sold and no changes in the respective market values occurred. The mortgage-backed securities held by the Bank include $385,071 fixed rate and no variable rate as held-to-maturity. The held-to-maturity mortgage-backed securities are stated at cost, adjusted for amortization of premiums and accretion of fees and discounts using a method that approximates a level yield. The available-for-sale mortgage-backed securities includes $178,268 fixed rate mortgage-backed securities and no variable rate mortgage-backed securities. The available-for-sale securities are carried at fair value. The following tables describe the composition of investments by major category and maturity at December 31, 1996: INVESTMENT PORTFOLIO Held-to- Available- Maturity for-Sale U.S. Treasury notes $ 3,001,104 $ 5,208,904 U.S. Government agencies 14,149,123 9,388,104 State and County Municipal securities 5,025,972 403,105 Mortgage backed securities 385,071 178,268 Other investments 1,042,892 ----------- ----------- Total $22,561,270 $16,221,273 =========== =========== -39- INVESTMENT PORTFOLIO MATURITY/REPRICING SCHEDULE
Maturing or Repricing ---------------------------------------------------------------------------------------------- After 1 Year but After 5 Years but Within 1 Year Within 5 Years Within 10 Years Other Securities -------------------- -------------------- -------------------- ---------------- Amount Yield Amount Yield Amount Yield Amount Yield ------ ----- ------ ----- ------ ----- ------ ----- Held-to-Maturity U.S. Treasury notes $3,001,104 5.7% U.S. Government agencies 999,744 6.1% $11,362,654 6.2% $1,786,725 6.9% Municipals 189,851 5.5% 2,634,459 6.1% 2,201,662 6.2% Mortgage-backed securities $385,071 5.7% ---------- ----------- ---------- -------- Total $4,190,699 $13,997,113 $3,988,387 $385,071 ========== =========== ========== ======== Available-for-Sale U.S. Treasury notes $5,010,310 5.7% $198,594 7.6% U.S. Government agencies 99,670 6.0% 4,391,614 7.2% $4,896,820 6.7% Mortgage-backed securities $178,269 7.6% Federal Reserve Bank stock 446,250 N/A Municipals 403,104 4.7% Other investments 596,642 N/A ---------- ---------- ---------- ---------- Total $5,109,980 $4,590,208 $5,299,924 $1,221,161 ========== ========== ========== ==========
Deposit Activities Deposits are attracted through the offering of a broad variety of deposit instruments, including checking accounts, money market accounts, regular savings accounts, term certificate accounts (including "jumbo" certificates in denominations of $100,000 or more), and retirement savings plans. The Company's average balance of total deposits was $145,632,109 for the year ended December 31, 1996, representing an increase of $49,433,814 or 51.4% compared with the average balance of total deposits for the year ended December 31, 1995. The Company's average balance of total deposits was $96,198,295 for the year ended December 31, 1995, representing an increase of $41,886,584 or 77.1% compared with the average balance of total deposits for the year ended December 31, 1994. The increases in deposits are due to both acquisitions and internally generated growth. The following table sets forth certain information regarding the Bank's average deposits as of December 31, 1996 and 1995: -40- AVERAGE DEPOSITS
December 31, 1996 December 31, 1995 ------------------------------------------ ----------------------------------------- Average Percent Average Average Percent Average Amount of Total Rate Paid Amount of Total Rate Paid ------ -------- --------- ------ -------- --------- Noninterest-bearing demand $20,089,712 13.8% N/A $12,889,281 13.4% N/A deposits Interest-bearing demand 36,910,314 25.3% 2.4% 23,106,404 24.0% 2.9% deposits Savings deposits 8,174,212 5.6% 2.1% 5,329,462 5.5% 2.4% Time deposits 80,397,763 55.3% 5.3% 54,873,148 57.1% 5.0% ---------- ===== --- ---------- ===== --- Total average deposits $145,572,001 100.0% 4.3% $96,198,295 100.0% 4.4% =========== ===== === ========== ===== ===
As of December 31, 1996 non-brokered time deposits over $100,000 represented 13.0% of total deposits, compared with 14.1% of total deposits as of December 31, 1995. As of December 31, 1996 jumbo certificates of deposits in excess of $100,000 accounted for $20,276,235 of the Bank's deposits. Of this amount, $19,227,000 had a maturity of one year or less. The Bank does not have and does not solicit brokered deposits. The following table sets forth the remaining maturities for time deposits of $100,000 or more at December 31, 1996 and 1995: TIME DEPOSITS OF $100,000 OR MORE Maturity Range December 31, 1996 December 31, 1995 -------------- ----------------- ----------------- Three months or less $8,626,435 $6,679,584 Three through six months 3,843,571 3,368,061 Six through twelve months 7,687,144 3,821,337 Over twelve months 119,085 1,603,692 ---------- ------------ Total $20,276,235 $15,472,674 ========== ========== Return on Equity and Assets The following are various ratios for the Company for the years ended December 31, 1996 and 1995: RETURN ON EQUITY AND ASSETS For the Year Ended December 31, ------------------------------- 1996 1995 ---- ---- Return on average assets 1.0% 0.8% Return on average equity 9.8% 9.5% Average equity to average assets 10.5% 8.7% -41- Liquidity The Bank's investment securities portfolio, including federal funds sold, and its cash and due from bank deposit balances serve as the primary sources of liquidity. At December 31, 1996, 13.0% of the Bank's interest-bearing liabilities were in the form of time deposits of $100,000 and over. Substantially all of such large deposits were obtained from the Bank's market area, and none were obtained through brokers. Management believes these deposits to be a stable source of funds. However, if a large number of these time deposits matured at approximately the same time and were not renewed, the Bank's liquidity could be adversely affected. Currently, the maturities of the Bank's large time deposits are spread throughout the year, with 43% maturing in the first quarter of 1996, 19% maturing in the second quarter of 1996, 38% maturing in the second half of 1996, and the remaining 0.6% maturing thereafter. The Bank monitors those maturities in an effort to minimize any adverse effect on liquidity. The Bank is limited through regulatory commitments from using brokered funds without prior approval. On February 28, 1996 the Company completed a primary and secondary offering of its Common Stock. The offering was underwritten by Hoefer & Arnett, Incorporated, a San Francisco investment banking firm. A total of 2,388,759 shares of Common Stock were sold in the offering at a price of $3.75 per share, including 288,759 shares of Common Stock sold as an over-allotment and 174,939 shares of Common Stock held by a shareholder of the Company. The proceeds from this offering were used by the Company to finance the acquisition of First National Bank, Midlothian, Texas, to retire the Company's outstanding bank debt and for general corporate purposes. On February 29, 1996 the Company completed the acquisition of First National Bank, Midlothian, Texas ("First National"), through the consolidation of First National and the Bank. In connection with the transaction, the Bank changed its main office to the former main office of First National in Midlothian, Texas, and operated its own former main office in Lufkin, Texas as a branch. Effective April 18, 1996, the Bank changed the location of its main office to Hurst, Texas, and operates its former main office in Midlothian, Texas as a branch. With the completion of this acquisition, the Bank increased its asset size by approximately 42%. As of December 31, 1995 First National had total assets of $51,253,000 and the Bank had total assets of $121,262,000. In the transaction, a subsidiary of the Bank was first merged with and into First National's parent holding company, First Midlothian Corporation ("First Midlothian"), pursuant to which merger the shareholders of First Midlothian received cash in exchange for their shares of capital stock of First Midlothian in an amount equal to approximately one hundred fifty percent (150%) of the book value of First National. Immediately following the merger, First National and the Bank consolidated under the charter of the Bank. The acquisition has been accounted for as a purchase in the accompanying consolidated financial statements. The assets and liabilities of First National have been recorded at their fair values as of February 29, 1996. The Company raised $1.2 million during 1995, $2.3 million during 1994, $852,000 during 1993, and $779,000 during 1992 through the sale, in registered offerings, private offerings and incentive stock option exercises, of the Company's Common Stock. Management anticipates that future registered and private offerings of the Company's Common Stock may be used to raise additional capital, in connection with acquisitions or if the regulatory capital requirements with which the Bank must comply necessitate the injection of additional capital by the Company into the Bank. Failure to raise such -42- additional capital could adversely impact the growth of the Bank or result in its failure to comply with applicable regulatory capital requirements, which could necessitate a reduction in the volume of assets and deposits of the Bank. Such reductions could adversely affect the Bank's earnings and liquidity. See "Item 1. Business - Supervision and Regulation: Capital Adequacy Guidelines." In the longer term, the liquidity of the Company and its ability to meet its cash obligations will depend substantially on its receipt of dividends from the Bank, which are limited by banking statutes and regulations. See "Item 1. Business - Supervision and Regulation." Capital Resources The Company's shareholders' equity at December 31, 1996 was $19.2 million, compared with $10.3 million at December 31, 1995. The growth in equity has been the result of the sale of Common Stock by the Company and the retention of earnings. The Company had consolidated income of $1,697,987 for the year ended December 31, 1996. There can be no assurance that the Company can continue to operate profitably in the future and failure to operate profitably would have a material adverse effect on the Company. The Bank is expected to meet a minimum risk-based capital ratio to risk-weighted assets ratio of 8%, of which at least one-half (or 4%) must be in the form of Tier 1 (core) capital. The remaining one-half (or 4%) may be either in the form of Tier 1 (core) or Tier 2 (supplementary) capital. The amount of loan loss allowance that may be included in capital is limited to 1.25% of risk-weighted assets. The ratio of Tier 1 (core) and the combined amount of Tier 1 (core) and Tier 2 (supplementary) capital to risk-weighted assets for the Bank were 11.10% and 12.29%, respectively, at December 31, 1996, and 10.76% and 11.72%, respectively, at December 31, 1995. The Bank is currently, and expects to continue to be, in compliance with these guidelines. See "Item 1. Business - Supervision and Regulation: Capital Adequacy Guidelines." The Board of Governors of the Federal Reserve System ("FRB") has announced a policy sometimes known as the "source of strength doctrine" which requires a bank holding company to serve as a source of financial and managerial strength to its subsidiary banks. The FRB has interpreted this requirement to require that a bank holding company, such as the Company, stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity. The FRB has stated that it would generally view a failure to assist a troubled or failing subsidiary bank in these circumstances as an unsound or unsafe banking practice or a violation of Regulation Y or both, justifying a cease and desist order or other enforcement action, particularly if appropriate resources are available to the bank holding company on a reasonable basis. The requirement that a bank holding company, such as the Company, make its assets and resources available to a failing subsidiary bank could have an adverse effect upon the Company and its shareholders. The following table sets forth an analysis of the Bank's capital ratios: -43- RISK-BASED CAPITAL RATIOS
Minimum Well- Capital Capitalized December 31, Ratios Ratios ----------------------------------------------------------------- ------------------------------- 1996 1995 1994 1993 ------ ------ ------ ---- Tier I risk-based capital $12,013,000 $7,964,000 $6,790,000 $3,821,000 Tier II risk-based capital 1,285,000 703,000 698,000 401,000 Total capital 13,298,000 8,667,000 7,488,000 4,222,000 Risk-weighted assets 108,208,000 73,983,000 67,011,000 33,594,000 Capital ratios: Tier I risk-based capital 11.10% 10.76% 10.13% 11.37% 4.00% 6.00% Tier II risk-based capital 12.29 11.72 11.17 12.57 8.00 10.00 Leverage ratio 7.02 6.88 5.56 9.96 4.00 5.00
Accounting Matters In May 1993 the Financial Accounting Standards Board ("FASB") issued SFAS No. 114 "Accounting by Creditors for Impairment of a Loan" as amended by SFAS No. 118 "Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures." Together, these standards require that when a loan is impaired, a creditor shall measure impairment based on the present value of expected future cash flows discounted at the loan's effective interest rate, the fair value of the collateral if the loan is collateral dependent or the loan's observable market price. A loan is considered impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. The new standards also require certain disclosures regarding impaired loans. The Company adopted these standards effective January 1, 1995. The adoption of these accounting standards did not have a material effect on the Company's consolidated financial position or results of operations since the Company's recognition and measurement policies regarding nonperforming loans are materially consistent with the accounting standards. In October 1995 FASB issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation." This Statement defines a fair value based method of accounting for an employee stock option or similar equity instrument and encourages all entities to adopt that method of accounting for all employee stock compensation plans. However, it also allows an entity to continue to measure compensation cost for those plans using the intrinsic value based method of accounting prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees." Entities electing to continue to use the method of accounting specified in Opinion 25 must make pro forma disclosures of net income and, if presented, earnings per share, as if the fair value method of accounting defined in this Statement had been applied. This Statement is effective for fiscal years beginning after December 15, 1995. The Company adopted this Statement effective January 1, 1996. Recent Accounting Pronouncements In June 1996, FASB issued Statement of Financial Accounting Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS 125"). This Statement provides consistent standards for distinguishing transfers of financial assets that are sales from -44- transfers that are secured borrowings. This Statement requires that after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. This Statement is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996. In December 1996, FASB issued Statement of Financial Accounting Standards No. 127, "Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125." This Statement deferred the effective date of FASB Statement No. 125 for secured lending, repurchase agreement, dollar-roll, securities lending, and similar transactions to transactions occurring after December 31, 1997. In February 1997, FASB issued Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("FAS 128"). FAS 128 simplifies the standards for computing earnings per share ("EPS") previously found in APB Opinion No. 15, "Earnings per Share" ("Opinion 15"), and make them comparable to international EPS standards. FAS 128 replaces the presentation of primary EPS with a presentation of basic EPS. Basic EPS excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. Diluted EPS is computed similarly to fully diluted EPS pursuant to Opinion 15. FAS 128 also requires dual presentation of basic and diluted EPS on the face of the income statement for entities with complex capital structures and a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. FAS 128 is effective for financial statements issued for periods ending after December 31, 1997, including interim periods; earlier application is not permitted. FAS 128 requires restatement of all prior-period EPS data presented. In February 1997, FASB issued Statement of Financial Accounting Standards No. 129, "Disclosure of Information about Capital Structure" ("FAS 129"). FAS 129 establishes standards for disclosing information about an entity's capital structure, including the pertinent rights and privileges of various securities outstanding. FAS 129 is effective for financial statements issued for periods after December 15, 1997. Management believes that the adoption of these pronouncements will not have a material impact on the financial statements of the Company. Impact of Inflation, Changing Prices and Monetary Policies The financial statements and related financial data concerning the Company in this report have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. The primary effect of inflation on the operations of the Company is reflected in increased operating costs. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, changes in interest rates have a more significant effect on the performance of a financial institution than do the effects of changes in the general rate of inflation and changes in prices. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services. Interest rates are highly sensitive to many factors which are beyond the control of the Bank, including the influence of domestic and foreign economic conditions and the monetary and -45- fiscal policies of the United States government and federal agencies, particularly the Federal Reserve Bank. The Federal Reserve Bank implements national monetary policy such as seeking to curb inflation and combat recession by its open market operations in United States government securities, control of the discount rate applicable to borrowing by banks and establishment of reserve requirements against bank deposits. The actions of the Federal Reserve Bank in these areas influence the growth of bank loans, investments and deposits, and affect the interest rates charged on loans and paid on deposits. The nature, timing and impact of any future changes in federal monetary and fiscal policies on the Bank and its results of operations are not predictable. Related Party Transactions In the ordinary course of business, the Bank has loans, deposits and other transactions with its executive officers and directors and businesses with which such persons are associated. It is the Company's policy that all such transactions are entered into on substantially the same terms as those prevailing at the time for comparable transactions with unrelated third parties. During 1996, the Bank extended loans of $398,000 to director-related companies. Subsequent Events None. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The financial statements and supplementary data required to be included in this Item 8 are set forth in Item 14 of this Report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. The Company has had no changes in accountants or disagreements with its accountants on accounting and disclosure to report under this Item 9. -46- PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. This information is incorporated by reference from the Company's definitive Proxy Statement for the Company's 1997 annual meeting for the fiscal year ended December 31, 1996, to be filed no later than April 30, 1997. ITEM 11. EXECUTIVE COMPENSATION. This information is incorporated by reference from the Company's definitive Proxy Statement for the Company's 1997 annual meeting for the fiscal year ended December 31, 1996, to be filed no later than April 30, 1997. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. This information is incorporated by reference from the Company's definitive Proxy Statement for the Company's 1997 annual meeting for the fiscal year ended December 31, 1996, to be filed no later than April 30, 1997. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. This information is incorporated by reference from the Company's definitive Proxy Statement for the Company's 1997 annual meeting for the fiscal year ended December 31, 1996, to be filed no later than April 30, 1997. -47- PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (a) Documents filed as part of Report. 1. Financial Statements Page The following financial statements of the Company required to be included in Item 8 are filed under Item 14 at the page indicated: Report of Independent Accountants F-1 Consolidated Balance Sheets at December 31, 1996 and 1995 F-2 Consolidated Statements of Income for the years ended December 31, 1996, 1995 and 1994 F-3 Consolidated Statements of Shareholders' Equity for the years ended December 31, 1996, 1995 and 1994 F-4 Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994 F-5 Notes to Consolidated Financial Statements F-7 2. Financial Statement Schedules No schedules are required because they are inapplicable or the information is otherwise shown in the financial statements or notes thereto. 3. Exhibits 2.01 Reorganization Agreement by and between Bancwell Financial Corp.; Dan W. Brent, Jody Pearson and Joe M. Pearson; Texas Bank, N.A.; and Surety Capital Corporation dated July 23, 1992; and Agreement to Merge Bank of East Texas with and into Texas Bank, N.A. under the Charter of Texas Bank, N.A. and under the Title of Texas Bank, N.A., dated July 23, 1992. (4) 2.02 Reorganization Agreement by and between Newell Bancshares, Inc.; Dan W. Brent, Jody Pearson and Joe M. Pearson; Texas Bank, N.A.; and Surety Capital Corporation dated July 23, 1992; and Agreement to Merge First State Bank with and into Texas Bank, N.A. under the Charter of Texas Bank, N.A. and under the Title of Texas Bank, N.A., dated July 23, 1992. (4) -48- 2.03 Reorganization Agreement by and between The Farmers Guaranty State Bank of Kennard; Dr. Frank A. Smith, III; Surety Bank, National Association; and Surety Capital Corporation, dated February 4, 1994; and Agreement to Merge The Farmers Guaranty State Bank of Kennard with and into Surety Bank, National Association under the Charter of Surety Bank, National Association and under the title of Surety Bank, National Association, dated February 4, 1994. (6) 2.04 Reorganization Agreement by and between First National Bank; Lloyd W. Butts, D. C. Degan, Norman Denton, Murriel Gilbreath, Robert S. Light, and Joe B. Turner, Jr. (the "Shareholders"); Surety Bank, National Association; and Surety Capital Corporation, dated May 24, 1994; and Agreement to Merge between Surety Bank, National Association, First National Bank and joined in by the Shareholders and Surety Capital Corporation, dated May 24, 1994. (7) 2.05 Reorganization Agreement by and between First Midlothian Corporation; First National Bank; certain individual shareholders and directors of First Midlothian Corporation and First National Bank; Surety Bank, National Association; and Surety Capital Corporation, dated October 17, 1995. (10) 2.06 Amendment Number One to Reorganization Agreement, dated January 16, 1996. (11) 2.07 Amendment Number Two to Reorganization Agreement, dated February 29, 1996. (11) 2.08 Agreement to Merge SCC Acquisition, Inc. with and into First Midlothian Corporation Under the Charter of First Midlothian Corporation and Under the Title of First Midlothian Corporation between First Midlothian Corporation and SCC Acquisition, Inc., and joined in by Surety Bank, National Association and the directors of First Midlothian Corporation and First National Bank, dated October 17, 1995. (10) 2.09 Amendment Number One to Agreement to Merge SCC Acquisition, Inc. with and into First Midlothian Corporation Under the Charter of First Midlothian Corporation and Under the Title of First Midlothian Corporation, dated February 29, 1996. (11) 2.10 Agreement to Consolidate First National Bank and Surety Bank, National Association under the Charter of Surety Bank, National Association and Under the Title of Surety Bank, National Association between Surety Bank, National Association and First National Bank, and joined in by SCC Acquisition, Inc. and Surety Capital Corporation, dated January 16, 1996. (10) 3.01 Certificate of Incorporation. (1) 3.02 Certificate of Amendment of Certificate of Incorporation, as filed with the Delaware Secretary of State on April 8, 1987. (2) 3.03 Certificate of Amendment to the Certificate of Incorporation, as filed with the Delaware Secretary of State on April 4, 1988. (3) 3.04 Certificate of Designations Establishing Series of Shares of Preferred Stock, as filed with the Delaware Secretary of State on April 4, 1988. (3) 3.05 Certification of Elimination of Series of Shares of Preferred Stock, as filed with the Delaware Secretary of State on January 31, 1992. (5) -49- 3.06 Certificate of Amendment to the Certificate of Incorporation, as filed with Delaware Secretary of State on June 14, 1993. (6) 3.07 Form of Common Stock certificate (specimen). (6) 3.08 Restated Bylaws of the Company. (8) 10.01 Pledge Agreement by and between Surety Capital Corporation and Overton Bank and Trust, N.A., dated December 9, 1994. (9) 10.02 Guaranty Agreement entered into by C. Jack Bean with Overton Bank and Trust, N.A. with respect to the repayment by Surety Capital Corporation of loan from Overton Bank and Trust, N.A., dated December 9, 1994. (9) 10.03 Uniform Commercial Code Financing Statement UCC-1 completed with respect to Overton Bank & Trust, N.A.'s security interest in the Shares of Stock of Surety Bank, National Association owned by Surety Capital Corporation. (9) 10.04 Promissory Note in the original principal amount of $500,000 with Surety Capital Corporation as borrower and Overton Bank and Trust, N.A. as lender, dated June 23, 1995 with a maturity date of January 23, 1996; and related Security Agreement (Collateral Pledge Agreement) dated June 23, 1995. (10) 10.05 Surety Capital Corporation 1988 Incentive Stock Option Plan. (5) 10.06 Form of Change in Control Agreement entered into between Surety Capital Corporation and C. Jack Bean, Bobby W. Hackler and G. M. Heinzelmann, III, dated August 16, 1994. (8) 10.07 Lease agreement between Precinct Campus, Inc., as landlord, and Surety Capital Corpo- ration, as tenant, regarding offices located in Hurst, Texas, dated February 14, 1994. (6) 10.08 Surety Capital Corporation 1995 Incentive Stock Option Plan. (8) 10.09 Form of Executive Deferred Compensation Agreements and related Adoption Agreements with Designation of Beneficiaries entered into between Surety Capital Corporation and Bobby W. Hackler and G. M. Heinzelmann, III, dated August 15, 1995. (10) 10.10 Form of Letter Agreements between Surety Capital Corporation and Bobby W. Hackler and G. M. Heinzelmann, III regarding provision by Surety Capital Corporation of term life insurance coverage, dated August 15, 1995. (10) 10.11 Change in Control Agreement entered into between Surety Capital Corporation and B. J. Curley, dated February 9, 1996. (12) 10.12 Asset Purchase Agreement by and among Surety Bank, National Association, Surety Capital Corporation, Providers Funding Corporation, and Lawrence C. Blanton, Barry T. Carroll and Bill M. Ward; Employment, Non-Competition and Confidentiality Agreement by and between Surety Bank, National Association, Surety Capital Corporation, and Barry T. Carroll; Non-Competition and Confidentiality Agreement by and between Surety Bank, National Association, Surety Capital Corporation, and Lawrence C. Blanton; and Non- Competition and Confidentiality Agreement by and between Surety Bank, National Association, Surety Capital Corporation, and Bill M. Ward; all dated March 15, 1996. (12) -50- 10.13 Executive Deferred Compensation Agreement and related Adoption Agreement with Designation of Beneficiaries entered into between Surety Capital Corporation and B. J. Curley, dated January 21, 1997. * 10.14 Letter Agreement between Surety Capital Corporation and B. J. Curley regarding provision by Surety Capital Corporation of term life insurance coverage, dated January 21, 1997. * 10.15 Surety Capital Corporation Amended and Restated Stock Option Plan for Directors, and Form of Stock Option Agreement. * 21 Subsidiaries of the Registrant. * 23 Consent of Coopers & Lybrand L.L.P. * 24 Special Power of Attorney. * 27 Financial Data Schedule. * (1) Filed with Registration Statement No. 33-1983 on Form S-1 and incorporated by reference herein. (2) Filed with the Company's Form 10-K dated October 31, 1987 and incorporated by reference herein. (3) Filed with the Company's Form 10-Q for the quarter ended April 30, 1988 and incorporated by reference herein. (4) Filed with Registration Statement No. 33-44893 on Form S-3 and incorporated by reference herein. (5) Filed with the Company's Form 10-K dated December 31, 1991 and incorporated by reference herein. (6) Filed with the Company's Form 10-K dated December 31, 1993 and incorporated by reference herein. (7) Filed with the Company's Form 8-K dated December 8, 1994 and incorporated by reference herein. (8) Filed with the Company's Form 10-K dated December 31, 1994 and incorporated by reference herein. (9) Filed with Registration Statement No. 33-89264 on Form S-2 and incorporated by reference herein. (10) Filed with Registration Statement No. 33-64789 on Form S-1 and incorporated by reference herein. (11) Filed with the Company's Form 8-K dated February 29, 1996 and incorporated by reference herein. (12) Filed with the Company's Form 10-K dated December 31, 1995 and incorporated by reference herein. * Filed herewith. -51- (b) Reports on Form 8-K. No reports on Form 8-K were filed by the Company during the fourth quarter of 1996. (c) Exhibits Required by Item 601 of Regulation S-K. The exhibits listed in Part IV, Item 14(a)(3) of this report, and not incorporated by reference to a separate file, are included after "Signatures," below. (d) Financial Statement Schedules Required by Regulation S-X. (Included under Part IV, Item 14(a)(2)). All schedules are omitted because they are not required, inapplicable or the information is otherwise shown in the financial statements or notes thereto. -52- SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SURETY CAPITAL CORPORATION Date: March 28, 1997 By: /s/ C. Jack Bean ----------------- C. Jack Bean, Chairman of the Board Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons in the capacities indicated on this 28th day of March, 1997. Signature Capacity --------- -------- /s/ C. Jack Bean Chairman of the Board, Chief Executive Officer - ---------------- and Director (Principal Executive Officer) C. Jack Bean /s/ G. M. Heinzelmann, III President and Director - -------------------------- G. M. Heinzelmann, III /s/ Bobby W. Hackler Vice Chairman of the Board, Chief Operating - -------------------- Officer and Director Bobby W. Hackler /s/ B. J. Curley Vice President, Chief Financial Officer and - ---------------- Secretary (Principal Financial Officer and Chief B. J. Curley Accounting Officer) * Director - ----------------- William B. Byrd * Director - ----------------- Joseph S. Hardin * Director - ----------------- Michael L. Milam -53- * Director - ----------------- Garrett Morris * Director - ----------------- Cullen W. Turner * By: /s/ C. Jack Bean C. Jack Bean, as Attorney-in-Fact for each of the persons indicated -54- Report of Independent Accountants Board of Directors and Shareholders Surety Capital Corporation Fort Worth, Texas We have audited the accompanying consolidated balance sheets of Surety Capital Corporation as of December 31, 1996 and 1995, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Surety Capital Corporation as of December 31, 1996 and 1995, and the consolidated results of operations and its cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. As discussed in Note 2 to the financial statements, Surety Capital Corporation changed its method of accounting for investment securities in 1994. Coopers & Lybrand L.L.P. Fort Worth, Texas January 21, 1997 F-1 SURETY CAPITAL CORPORATION CONSOLIDATED BALANCE SHEETS December 31, 1996 and 1995
ASSETS December 31, December 31, 1996 1995 --------------- ---------------- Assets: Cash and due from banks $6,094,457 $4,727,018 Federal funds sold 16,772,000 18,490,000 Interest bearing deposits in financial institutions 285,842 1,046,297 Investment securities: Available-for-sale 16,221,273 10,128,157 Held-to-maturity 22,561,270 13,780,538 --------------- ---------------- Total investment securities 38,782,543 23,908,695 Loans 105,696,491 68,991,700 Less: Unearned interest (2,544,803) (1,889,461) Allowance for credit losses (1,284,774) (702,927) --------------- ---------------- Loans, net 101,866,914 66,399,312 Premises and equipment, net 3,970,193 2,775,688 Accrued interest receivable 1,083,336 781,031 Other real estate and repossessed assets 738,198 85,528 Other assets 607,214 467,147 Excess of cost over fair value of net assets acquired, net of Accumulated amortization of $719,288 and $359,572 at December 31, 1996 and 1995, respectively 6,238,613 2,658,557 --------------- ---------------- Total assets $176,439,310 $121,339,273 =============== ================ Liabilities and shareholders' equity: Demand deposits $23,878,744 $13,182,888 Savings, NOW and money markets 48,372,642 30,612,855 Time deposits, $100,000 and over 20,276,235 15,472,674 Other time deposits 63,162,720 50,330,085 --------------- ---------------- Total deposits 155,690,341 109,598,502 Note payable 375,000 Accrued interest payable and other liabilities 1,518,417 1,071,299 --------------- ---------------- Total liabilities 157,208,758 111,044,801 --------------- ---------------- Commitments and contingent liabilities (Notes 10 & 16) Shareholders' equity: Preferred stock, $.01 par value, 20,000,000 shares authorized, none issued at December 31, 1996 and 1995 Common stock, $.01 par value, 20,000,000 shares authorized, 5,763,737 and 3,516,595 shares issued at December 31, 1996 and 1995, respectively, and 5,748,119 and 3,506,429 outstanding at December 31, 1996 and 1995, respectively 57,637 35,166 Additional paid-in capital 16,752,003 9,356,469 Retained earnings 2,509,771 811,784 Treasury stock, 15,618 and 10,166 shares carried at cost at Decem- ber 31, 1996 and 1995, respectively (74,539) (50,830) Unrealized gain/(loss) on available-for-sale securities, net of tax (14,320) 141,883 --------------- ---------------- Total shareholders' equity 19,230,552 10,294,472 --------------- ---------------- Total liabilities and shareholders' equity $176,439,310 $121,339,273 =============== ================
The accompanying notes are an integral part of the consolidated financial statements. F-2 SURETY CAPITAL CORPORATION CONSOLIDATED STATEMENTS OF INCOME for the years ended December 31, 1996, 1995 and 1994
1996 1995 1994 ---- ---- ---- Interest income: Commercial and real estate loans .......... $ 5,772,065 $ 3,664,124 $ 1,422,911 Consumer loans ............................ 1,444,189 1,198,632 1,059,188 Insurance premium financing ............... 3,563,467 2,739,060 2,172,038 Federal funds sold ........................ 1,078,618 657,809 302,621 Investment securities Taxable ................................. 2,165,301 905,046 338,286 Tax-exempt .............................. 324,605 268,702 23,792 Interest bearing deposits ................. 42,117 101,408 68,173 ----------- ----------- ----------- Total interest income ................. 14,390,362 9,534,781 5,387,009 ----------- ----------- ----------- Interest expense: Savings, NOW and money market ............. 1,056,884 805,514 353,123 Time deposits, $100,000 and over .......... 1,106,754 792,098 362,700 Other time deposits ....................... 3,191,439 1,957,288 760,833 Other interest expense .................... 6,612 122,579 11,075 ----------- ----------- ----------- Total interest expense ................ 5,361,689 3,677,479 1,487,731 ----------- ----------- ----------- Net interest income before provision for credit losses ......... 9,028,673 5,857,302 3,899,278 Provision for credit losses ................. 135,000 60,000 106,899 ----------- ----------- ----------- Net interest income ................... 8,893,673 5,797,302 3,792,379 ----------- ----------- ----------- Noninterest income .......................... 1,877,454 1,419,067 1,160,007 ----------- ----------- ----------- Noninterest expense: Salaries and employee benefits ............ 4,244,874 2,923,118 2,201,188 Occupancy and equipment ................... 1,244,551 907,286 669,936 General and administrative ................ 2,645,587 2,048,148 1,590,814 ----------- ----------- ----------- Total noninterest expense ............. 8,135,012 5,878,552 4,461,938 ----------- ----------- ----------- Income before income taxes ........... 2,636,115 1,337,817 490,448 Income tax expenses: Current ................................... 938,128 263,007 36,697 Deferred .................................. 0 187,924 (19,009) ----------- ----------- ----------- Net income ............................ $ 1,697,987 $ 886,886 $ 472,760 =========== =========== =========== Net income per share of common stock ........ $ .32 $ .27 $ .20 =========== =========== =========== Weighted average shares outstanding ......... 5,389,366 3,279,448 2,393,841 =========== =========== ===========
The accompanying notes are an integral part of the consolidated financial statements. F-3 SURETY CAPITAL CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY for the years ended December 31, 1996, 1995 and 1994
Unrealized Gain/ Common Stock (Loss) on --------------------- Additional Retained Available- Par Paid-in Earnings/ Treasury for-Sale Total Shares Value Capital (Deficit) Stock Securities Equity ----------- --------- ------------ ------------- -------------- -------------- ------------ Balance at December 31, 1993 2,273,487 $22,734 $5,806,116 $ (547,862) - - $5,280,988 Sale of Common Stock 767,342 7,674 2,307,098 2,314,772 Net Income 472,760 472,760 Unrealized loss on available- for-sale securities, net of $ (2,839) (2,839) tax of $1,462 ----------- --------- ------------ ------------- -------------- -------------- ------------ Balance at December 31, 1994 3,040,829 30,408 8,113,214 (75,102) - (2,839) 8,065,681 ----------- --------- ------------ ------------- -------------- -------------- ------------ Sale of Common Stock 459,500 4,595 1,192,587 1,197,182 Purchase of Treasury Stock $ (50,830) (50,830) Net Income 886,886 886,886 Exercise of stock options 16,266 163 50,668 50,831 Change in unrealized gain/(losses) on available-for-sale securities, net of tax of $74,544 144,722 144,722 ----------- --------- ------------ ------------- -------------- -------------- ------------ Balance at December 31, 1995 3,516,595 35,166 9,356,469 811,784 (50,830) 141,883 10,294,472 ----------- --------- ------------ ------------- -------------- -------------- ------------ Sale of Common Stock 2,239,218 22,392 7,371,901 7,394,293 Purchase of Treasury Stock (23,709) (23,709) Net Income 1,697,987 1,697,987 Exercise of stock options 7,924 79 23,633 23,712 Change in unrealized gain/(losses) on available-for-sale securities, net of tax of $81,147 (156,203) (156,203) ----------- --------- ------------ ------------- -------------- -------------- ------------ Balance at December 31, 1996 5,763,737 $57,637 $16,752,003 $2,509,771 $ (74,539) $ (14,320) $19,230,552 =========== ========= ============ ============= ============== ============== ============
The accompanying notes are an integral part of the consolidated financial statements. F-4 SURETY CAPITAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS for the years ended December 31, 1996, 1995 and 1994
December 31, -------------------------------------------------------- 1996 1995 1994 ----------------- --------------- ---------------- Cash flows from operating activities: Net income $1,697,987 $886,886 $472,760 Adjustments to reconcile net income to net cash provided by operating activities: Provision for credit losses 135,000 60,000 106,899 Provision for depreciation 573,745 500,725 330,644 Amortization of intangible assets 359,717 184,332 51,201 Gain on sale or disposal of assets (22,879) (8,477) (15,508) Net increase in unearned interest on loans 655,342 382,618 136,614 Net (decrease) increase in other assets 14,925 (353,503) (220,707) Net (decrease increase in accrued interest payable and other liabilities (101,725) 411,209 (122,438) ----------------- --------------- ---------------- Net cash provided by operating activities 3,312,112 2,063,790 739,465 ----------------- --------------- ---------------- Cash flows from investing activities: Net increase in loans (15,070,139) (1,486,861) (7,760,672) Payments received on purchased medical claims receivables 14,229,677 15,716,784 12,290,141 Purchases of medical claims receivables (17,480,467) (16,688,775) (11,229,044) Purchases of available-for-sale securities (7,239,958) (7,356,633) Proceeds from sales of available-for-sale securities 4,736,638 Proceeds from maturities of available-for-sale securities 909,492 2,670,121 169,971 Purchases of held-to-maturity securities (3,081,744) (7,048,483) (316,276) Proceeds from maturities of held-to-maturity securities 15,515,641 2,808,990 4,556,981 Purchases of interest bearing deposits in financial (99,081) 500,000 institutions Proceeds from maturities of interest bearing deposits in financial institutions 1,034,697 576,972 712,743 Purchases of bank premises and equipment (518,010) (609,135) (420,487) Proceeds from sales of bank premises and equipment 4,437 6,000 16,308 Proceeds from sale of other real estate and repossessed 428,217 507,208 assets Net cash acquired in acquisitions 3,731,462 15,370,125 2,509,161 ----------------- --------------- ---------------- Net cash (used in) provided by investing activities (7,536,695) 9,103,870 1,028,826 ----------------- --------------- ---------------- Cash flows from financing activities: Net (decrease) increase in deposits (3,145,274) 1,032,815 (1,525,190) Proceeds from issuance of note payable 1,750,000 Principal payments on note payable (375,000) (1,375,000) Purchase of treasury stock (23,709) (50,830) Exercise of stock options 23,712 50,831 Proceeds from the sale of stock 7,394,293 1,197,182 2,314,772 ----------------- --------------- ---------------- Net cash provided by financing activities 3,874,022 854,998 2,539,582 ----------------- --------------- ---------------- Net (decrease) increase in cash and cash equivalents (350,561) 12,022,658 4,307,873 Beginning cash and cash equivalents 23,217,018 11,194,360 6,886,487 ----------------- --------------- ---------------- Ending cash and cash equivalents $22,866,457 $23,217,018 $11,194,360 ================= =============== ================
The accompanying notes are an integral part of the consolidated financial statements. F-5 SURETY CAPITAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS for the years ended December 31, 1996, 1995 and 1994
December 31, -------------------------------------------------------- 1996 1995 1994 ------------------ ---------------- --------------- Supplemental disclosure: Cash paid during the period for interest $ 5,190,521 $ 3,421,225 $ 1,339,223 Cash paid during the period for federal income taxes $ 545,000 $ 22,733 $ 12,000 Supplemental schedule of noncash investing and financing activities: Transfers of repossessed collateral to other assets $ 752,648 $ 457,483 $ 241,189 Additions to loans to facilitate the sale of OREO and other assets $ 212,715 $ 162,385 Supplemental schedule of investing activities: Interest bearing deposits in financial institutions $ 274,242 $ 1,588,931 Investment securities 21,214,629 16,196,901 Loans, net 18,476,948 $ 875,159 26,363,109 Premises and equipment, net 1,270,401 273,677 999,713 Other assets 959,648 6,569 474,002 Excess of cost over fair value of net assets acquired 3,939,773 151,365 2,239,171 Deposits (49,237,113) (16,538,565) (49,956,393) Other liabilities (629,990) (138,330) (414,595) ------------------ ---------------- --------------- Net cash acquired in acquisitions $ (3,731,462) $ (15,370,125) $ (2,509,161) ================== ================ ===============
The accompanying notes are an integral part of the consolidated financial statements. F-6 SURETY CAPITAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Basis of Presentation: The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Surety Bank, National Association (the "Bank"), which was acquired on December 30, 1989. All significant intercompany accounts and transactions have been eliminated in consolidation. 2. Summary of Significant Accounting Policies: Cash and Cash Equivalents For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, and federal funds sold. Generally, federal funds are sold for one day periods. Investment Securities Effective January 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115"). This statement addresses the accounting and reporting for investments in debt and equity securities that have readily determined fair values. Management determines the appropriate classification of securities at the time of purchase. If the securities are purchased with the positive intent and the ability to hold the securities until maturity, they are classified as held-to-maturity and carried at historical cost, adjusted for amortization of premiums and accretion of fees and discounts using a method that approximates the interest method. Securities to be held for indefinite periods of time are classified as available-for-sale and carried at fair value. Unrealized gains and losses, net of taxes, related to securities available-for-sale are recorded as a separate component of shareholders' equity. Securities purchased and held principally for the purpose of selling them in the near term are classified as trading. The Company had no securities classified as trading as of December 31, 1996 or 1995. The cost of securities sold is based on the specific identification method. Loans and Allowance for Credit Losses Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding principal adjusted for any charge-offs, the allowance for credit losses, and deferred fees or costs on originated loans. Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield of the related loan. Loans are stated at the amount of unpaid principal, reduced by unearned interest and an allowance for credit losses. The allowance for credit losses is established through a provision for credit losses charged against current earnings. A loan is considered impaired if, based on current information and events, it is possible that the Company will be unable to collect the scheduled payments of principal and interest when due, according to the contracted terms of the loan agreement. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrower's ability to pay. The measurement of impaired loans and the related allowance for credit losses is generally based on the fair value of the collateral. Smaller balance homogeneous loans consisting of residential mortgages and consumer loans are eveluated for reserves collectibility based on historical loss experience. Loans are charged against the allowance for credit losses when management believes that the collectibility of the principal is unlikely. The accrual of interest on impaired loans is discontinued when, in management's opinion, the borrower may be unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income subsequently recognized only to the extent cash payments are received. F-7 2. Summary of Significant Accounting Policies, continued: Loans and Allowance for Credit Losses, continued: Interest income on insurance premium financing loans and installment loans is recognized by a method which approximates the interest method. Interest income on commercial and real estate loans is accrued daily on the amount of outstanding principal. Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions and collection efforts, that a borrower's financial condition is such that collection of interest and principal is doubtful. Management evaluates the book value (including accrued interest) and collateral value on loans placed on nonaccrual status and provides specific allowance for credit losses as deemed appropriate. Premises and Equipment Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method at rates sufficient to amortize the cost over the estimated lives of the assets. Expenditures for repairs and maintenance are expensed as incurred, and renewals and betterments that extend the lives of assets are capitalized. Cost and accumulated depreciation are eliminated from the accounts when assets are sold or retired and any resulting gain or loss is reflected in operations in the year of disposition. Other Real Estate and Repossessed Assets Real estate properties acquired through, or in lieu, of loan foreclosure are to be sold and are initially recorded at fair value at the date of foreclosure establishing a new cost basis. After foreclosure, valuations are periodically performed by management and the real estate is carried at the lower of carrying amount or fair value less cost to sell. Any write down to fair market value at the date of acquisition is charged against the allowance for credit losses. Any subsequent write-downs are reflected in operations. Income Per Share Net income per share of common stock is computed based upon the weighted average number of shares of common stock outstanding during the years ended December 31, 1996, 1995 and 1994. Income Taxes The Company's method of accounting for income taxes utilized an asset and liability approach for financial statement purposes. The types of differences between the tax bases of assets and liabilities and their financial reporting amounts that give rise to significant portions of deferred income tax liabilities or assets include: allowances for possible credit losses, property and equipment, investment securities and net operating loss carryforwards. Purchase Method of Accounting Net assets acquired in purchase transactions are recorded at their fair value at the date of acquisition. The excess of the purchase price over the fair value of net assets acquired is amortized on a straight-line basis, generally over a 15 year period. The Company continually re-evaluates the propriety of the carrying amount of such intangible assets as well as its amortization period, to determine whether current events and circumstances warrant adjustments to the carrying value and/or revised estimates of the period of benefit. At this time, the Company believes that no significant impairment of such intangible asset has occurred and that no reduction of amortization period is warranted. F-8 2. Summary of Significant Accounting Policies, continued: Fair Values of Financial Instruments The following methods and assumptions were used by the Bank in estimating fair values of financial instruments as disclosed herein: Cash and short-term instruments. The carrying amounts of cash and short-term instruments approximate their fair value. Available-for-sale and held-to-maturity securities. Fair values for securities, excluding restricted equity securities, are based on quoted market prices. The carrying values of restricted equity securities approximate their fair values. Loans receivable. For variable-rate loans that reprice frequently and have no significant change in credit risk, fair values are base on carrying values. Fair values for certain mortgage loans, (for example, one-to-four family residential) and other consumer loans are based on quoted market prices of similar loans sold in conjunction with securitization transactions, adjusted for differences in loan characteristics. Fair values for commercial real estate and commercial loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for impaired loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable. Deposit liabilities. The fair values disclosed for demand deposits are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). The carrying amounts of variable-rate, fixed-term money market accounts and certificates of deposit (CDs) approximate their fair values at the reporting date. Fair values for fixed-rate CDs are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits. Accrued interest. The carrying amounts of accrued interest approximate their fair values. Off-balance sheet instruments. Fair values for off-balance sheet lending commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Recent Accounting Pronouncements In June 1996, the FASB issued Statement of Financial Accounting Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS 125"). This Statement provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. This Statement requires that after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. This Statement is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996. In December 1996, the FASB issued Statement of Financial Accounting Standards No. 127, "Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125." This Statement deferred the effective date of FASB Statement No. 125 for secured lending, repurchase agreement, dollar-roll, securities lending, and similar transactions to transactions occurring after December 31, 1997. F-9 2. Summary of Significant Accounting Policies, continued: In February 1997, the FASB issued Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("FAS 128"). FAS 128 simplifies the standards for computing earnings per share ("EPS") previously found in APB Opinion No. 15, "Earnings per Share" ("Opinion 15"), and make them comparable to international EPS standards. FAS 128 replaces the presentation of primary EPS with a presentation of basic EPS. Basic EPS excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. Diluted EPS is computed similarly to fully diluted EPS pursuant to Opinion 15. FAS 128 also requires dual presentation of basic and diluted EPS on the face of the income statement for entities with complex capital structures and a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. FAS 128 is effective for financial statements issued for periods ending after December 31, 1997, including interim periods; earlier application is not permitted. FAS 128 requires restatement of all prior-period EPS data presented. In February 1997, the FASB issued Statement of Financial Accounting Standards No. 129, "Disclosure of Information About Capital Structure" ("FAS 129"). FAS 129 establishes standards for disclosing information about an entity's capital structure, including the pertinent rights and privileges of various securities outstanding. FAS 129 is effective for financial statements issued for periods ending after December 15, 1997. Management believes that the adoption of these pronouncements will not have a material impact on the financial statements of the Company. 3. Acquisitions: Bank One, Texas, National Association Branch in Waxahachie, Texas On September 28, 1995, the Bank acquired certain assets (principally cash) and assumed certain liabilities (principally customer deposits) relating to the branch of Bank One, Texas, National Association ("Bank One") located in Waxahachie, Texas, (the "Waxahachie Branch"). The Bank financed the acquisition through the use of internally-generated funds. At the closing, the Bank assumed deposits and other liabilities totaling approximately $16,539,000. In addition, the Bank acquired certain small business and consumer loans totaling approximately $875,000, certain real property, furniture and equipment totaling approximately $274,000, and cash and other assets totaling approximately $15,426,000. After paying a deposit premium of two percent (2%) on the deposits assumed totaling approximately $331,000, the Bank received approximately $15,419,000 in cash from Bank One as consideration for the net deposit liabilities assumed. The Waxahachie Branch and deposits acquired in the acquisition have been incorporated into the Bank's existing branch network. First National Bank, Midlothian, Texas On February 28, 1996 the Company completed a primary and secondary offering of its Common Stock. The offering was underwritten by Hoefer & Arnett, Incorporated, a San Francisco investment banking firm. A total of 2,388,759 shares of Common Stock were sold in the offering at a price of $3.75 per share, including 288,759 shares of Common Stock sold as an over-allotment and 174,939 shares of Common Stock held by a shareholder of the Company. The proceeds from this offering were used by the Company to finance the acquisition of First National Bank, Midlothian, Texas, to retire the Company's outstanding bank debt and for general corporate purposes. On February 29, 1996 the Company completed the acquisition of First Midlothian Corporation, a Texas bank holding company located in Midlothian, Texas ("First Midlothian"), and its wholly owned subsidiary, First National Bank, Midlothian, Texas ("First National"). F-10 3. Acquisitions, continued: With the completion of this acquisition, the Bank increased its asset size by approximately 42%. In the transaction, a subsidiary of the Bank was first merged with and into First Midlothian, pursuant to which merger the shareholders of First Midlothian received cash in exchange for their shares of capital stock of First Midlothian in an amount equal to approximately one hundred fifty percent (150%) of the book value of First National. The Bank paid $5,976,000 to the shareholders of First National in exchange for all of the issued and outstanding shares of common stock of First National plus an additional $619,707 to repay in full all outstanding debentures of First Midlothian. The purchase of First National resulted in cost in excess of net assets acquired amounting to $2,553,638, which is being amortized on a straight line basis over a 15-year period. The assets and liabilities of First National have been recorded at their fair values as of February 29, 1996. Purchase accounting mark-to-market adjustments for the purchase of First National resulted in a net increase in assets of $268,818. Immediately following the merger, First National and the Bank consolidated under the charter of the Bank. The acquisition has been accounted for as a purchase in the accompanying consolidated financial statements. Included in the accompanying consolidated financial statements are the following amounts for First National as of December 31, 1996 and for the twelve months ended December 31, 1996: Balance sheet data: Cash and due from banks $ 310,442 Federal funds sold 12,000,000 Investment securities 15,246,465 Net loans 14,942,495 Premises and equipment, net 1,395,777 Accrued interest receivable 106,788 Other assets 589,064 --------------- Total assets $ 44,591,031 =============== Deposits $ 43,980,472 Accrued interest payable 264,692 Income statement data: Total interest income $ 2,382,278 Total interest expense 1,163,786 Other income 312,154 Noninterest expense 1,276,156 --------------- Net income $ 254,490 =============== The consolidated results of operations include the operations of First National subsequent to March 1, 1996. The unaudited pro forma information for the twelve months ended December 31, 1996 and the unaudited pro forma information for the twelve months ended December 31, 1995, presented below, reflect the acquisition of First National as if it had been acquired as of January 1, 1995. Pro forma adjustments consisting of a provision for income taxes and interest expense have been made to properly reflect the unaudited pro forma information.
Twelve months ended Twelve months ended December 31, 1996 December 31, 1995 ----------------- ----------------- Interest income $14,998,219 $ 13,179,319 Net income 1,274,313 1,128,635 Net income per share of common stock $0.22 $0.20
F-11 3. Acquisitions, continued: Providers Funding Corporation On March 15, 1996, the Bank completed the acquisition of Providers Funding Corporation ("PFC"), a Dallas-based medical claims servicing company. The acquisition was accomplished through the purchase of certain assets consisting of accounts receivables along with certain furniture and equipment and the assumption of certain liabilities of PFC by the Bank. The Bank used cash on hand in the amount of $1,000,000 to fund this purchase (before deducting the then outstanding balance of principal plus interest on the indebtedness of PFC to the Bank). The Bank also entered into non-competition and confidentiality agreements with certain principals of PFC in consideration for which the Company issued 25,398 shares of Common Stock of the Company to such principals. The purchase of PFC resulted in cost in excess of net assets acquired amounting to $1,338,364 and is being amortized on a straight line basis over a 15-year period. Due to the short term nature of the receivables (average life of 90 days) and the short term nature of the liabilities (less than 30 days), no purchase accounting mark-to-market adjustments were necessary. The acquisition has been accounted for as a purchase in the accompanying consolidated financial statements. The Bank operates PFC as a division titled "Providers Funding a division of Surety Bank, N.A.". 4. Investment Securities: Investment securities consisted of the following at December 31, 1996 and 1995:
December 31, 1996: Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ------------- ---------- ---------- ------------ Available-for-Sale: U.S. Treasury $ 5,193,782 $ 15,122 $ 5,208,904 Obligations of other U.S. Government agencies and corporations 9,423,964 39,027 $ 74,887 9,388,104 State and county municipals 409,498 15 6,408 403,105 Mortgage-backed securities 173,513 4,755 178,268 Other securities 1,042,892 1,042,892 ------------- ---------- ----------- ------------ Total available-for-sale $16,243,649 $ 58,919 $ 81,295 $ 16,221,273 ============= ========== =========== ============ Held-to-Maturity: U.S. Treasury $ 3,001,104 $ 4,216 $ 3,005,320 Obligations of other U.S. Government agencies and corporations 14,149,123 42,723 $ 15,697 14,176,149 State and county municipals 5,025,972 170,621 238 5,196,355 Mortgage-backed securities 385,071 357 385,428 ------------- ---------- ---------- ------------ Total held-to-maturity $22,561,270 $ 217,917 $ 15,935 $ 22,763,252 ============= ========== ========== ============
F-12 4. Investment Securities, continued:
December 31, 1995: Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ---- ----- ------ ----- Available-for-Sale: U.S. Treasury $ 485,991 $ 11,978 $ 497,969 Obligations of other U.S. Government agencies and corporations 8,525,194 199,736 8,724,930 State and county municipals 411,394 338 $ 7,475 404,257 Mortgage-backed securities 209,529 10,397 219,926 Other securities 281,075 281,075 ----------- --------- ---------- ------------ Total available-for-sale $ 9,913,183 $ 222,449 $ 7,475 $ 10,128,157 =========== ========= ========== ============ Held-to-Maturity: U.S. Treasury Obligations of other U.S. Government agencies and corporations $ 8,563,315 $ 59,020 $ 3,882 $ 8,618,453 State and county municipals 4,730,921 245,828 4,976,749 Mortgage-backed securities 486,302 325 3,811 482,816 ----------- --------- ---------- ------------ Total held-to-maturity $13,780,538 $ 305,173 $ 7,693 $ 14,078,018 =========== ========= ========== ============
The amortized cost and estimated market value of investment securities at December 31, 1996 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Estimated December 31, 1996: Amortized Fair Cost Value ---- ----- Available-for-Sale: Due within one year $ 5,100,083 $ 5,109,980 Due after one year through five years 4,579,871 4,590,208 Due after five years through ten years 5,347,290 5,299,924 Mortgage-backed securities 173,513 178,269 Other securities 1,042,892 1,042,892 ------------- -------------- Total available-for-sale $16,243,649 $16,221,273 ============= ============== Held-to-Maturity: Due within one year $ 4,190,699 $ 4,191,974 Due after one year through five years 13,997,113 14,114,613 Due after five years through ten years 3,988,387 4,071,237 Mortgage-backed securities 385,071 385,428 ----------- ------------- Total held-to-maturity $22,561,270 $22,763,252 =========== =============
No sales of available-for-sale investment securities occurred during 1996. Proceeds from sales of available-for-sale investment securities during the year ended December 31, 1995 were $4,736,538 with gross recognized gains of $100 and no losses. F-13 4. Investment Securities, continued: Proceeds from sales of held-to-maturity investment securities during the twelve months ended December 31, 1994 were $500,000 with no recognized gains or losses. These securities were sold within 90 days of the call date and were expected to be called. At December 31, 1996 and 1995 the carrying values of Federal Reserve Bank stock were $446,250, and $261,150, respectively. The Federal Reserve Bank stock's market value was estimated to be the same as its carrying value at all dates. At December 31, 1996 and 1995 securities with a carrying amount of $20,927,000 and $10,734,000, respectively, were pledged as collateral for public deposits, as required or permitted by law. 5. Loans, net: At December 31, 1996 and 1995, the loan portfolio was composed of the following: December 31, December 31, 1996 1995 --------------- ---------------- Insurance premium financing $39,168,604 $22,409,356 Installment loans 12,631,520 10,645,406 Commercial loans 22,745,139 16,301,840 Real estate loans 24,774,167 16,281,558 Medical claims receivable 6,377,061 3,353,540 --------------- ---------------- Total gross loans 105,696,491 68,991,700 Unearned interest (2,544,803) (1,889,461) Allowance for credit losses (1,284,774) (702,927) --------------- ---------------- Loans, net $101,866,914 $66,399,312 ============== ================ Loans on which the accrual of interest has been discontinued amounted to approximately $144,000 and $27,000 at December 31, 1996 and 1995, respectively. A summary of changes in allowance for credit losses for the years ended December 31, 1996 and December 31, 1995 were as follows: December 31, December 31, 1996 1995 ------------ ----------- Balance at beginning of year $702,927 $697,948 Additions (deductions): Provision for credit losses 135,000 60,000 Bank acquisitions 614,700 10,759 Loans charged off (229,418) (117,446) Recoveries of loans previously charged-off 61,565 51,666 ---------- -------- Balance at end of year $1,284,774 $702,927 ========== ======== F-14 5. Loans, net, continued: At December 31, 1996 and December 31, 1995, the Company's recorded investment in loans for which impairment has been recognized in accordance with Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan," (SFAS 114) consists primarily of commercial loans and installment loans as follows:
December 31, December 31, 1996 1995 ---------- ---------- Impaired loans $4,837,271 $1,282,701 Impaired loans with related allowance calculated under SFAS 114 3,209,403 950,196 Allowance on impaired loans calculated under SFAS 114 387,386 76,692 Impaired loans with no allowance calculated under SFAS 114 1,627,868 332,505
For the year ended December 31, 1996 1995 ---------- ---------- Average impaired loans $3,436,870 $1,102,871 Interest income recognized on impaired loans 415,861 123,522
As of December 31, 1996 and December 31, 1995, there were no commitments to lend additional funds for loans considered impaired. 6. Premises and Equipment: Premises and equipment at December 31, 1996 and 1995 are summarized as follows:
Estimated Useful Lives 1996 1995 -------------- ----------- ----------- Buildings 5 - 30 years $2,203,262 $1,397,245 Furniture, fixtures and computers 3 - 10 years 2,795,616 2,148,112 Automobiles 3 - 5 years 375,361 264,709 Leasehold improvements 3 - 5 years 100,470 93,840 ----------- ----------- 5,474,709 3,903,906 Less accumulated depreciation (1,920,545) (1,346,747) Land 416,029 218,529 ----------- ----------- Net premises and equipment $3,970,193 $2,775,688 =========== ===========
7. Deposits: At December 31, 1996 and 1995, the scheduled maturities of time deposits of less than $100,000 are as follows: 1996 1995 ----------- ----------- Three months or less $18,379,000 $12,701,000 Over three months through 12 months 36,698,000 28,142,000 Over one year 8,086,000 9,487,000 --------- --------- $63,163,000 $50,330,000 =========== =========== F-15 7. Deposits, continued: At December 31, 1996 and 1995, the scheduled maturities of time deposits of $100,000 or more are as follows: 1996 1995 ----------- ----------- Three months or less $8,626,000 $6,680,000 Over three months through 12 months 11,531,000 7,189,000 Over one year 119,000 1,604,000 ----------- ----------- $20,276,000 $15,473,000 =========== =========== 8. Shareholders' Equity: During the year ended December 31, 1996, 2,239,218 shares of the Company's common stock were sold in a public offering for a total consideration, net of expenses, of $7,394,293. During the year ended December 31, 1995, 459,500 shares of the Company's common stock were sold in a private offering for a total consideration, net of expenses, of $1,197,182. During the year ended December 31, 1994, 767,342 shares of the Company's common stock were sold in private placements for a total consideration, net of expenses, of $2,314,772. 9. Stock Options and Warrants: The Company has three stock-based compensation plans, which are described below. The Company applies accounting Principles Board Opinion 25 ("APB 25") and related Interpretations in acounting for its stock-based compensation plans. In 1995, the FASB issued FASB Statement No. 123 "Accounting for Stock-Based Compensation" ("SFAS 123") which, if fully adopted by the Company, would change the methods the Company applies in recognizing the cost of its stock-based compensation plans. Adoption of the cost recognition provisions of SFAS 123 is optional and the Company has decided not to elect these provisions of SFAS 123. However, pro forma disclosures as if the Company adopted the cost recognition provisions of SFAS 123 in 1995 are required by SFAS 123 and are presented below. The Company has adopted three stock option plans, the 1988 Incentive Stock Option Plan and the 1995 Incentive Stock Option Plan, and the Directors Stock Option Plan (collectively, the "Stock Option Plans"). Under each Stock Option Plan, the Company is authorized to issue up to 100,000 shares of Common Stock pursuant to stock options to selected employees and directors. The Company is authorized under the Stock Option Plans to grant stock options as incentive stock options (intended to qualify under Section 422 of the Internal Revenue Code of 1986, as amended) to employees and nonstatutory stock options to directors. The Stock Option Plans provide that the exercise price of any stock option may not be less than the fair market value of the Common Stock on the date of the grant. Options granted in 1995 have contractual terms of 5 years and options granted in 1996 have contractual terms of 10 years. The 1995 options are 100% vested as of the date of the grant. Of the 1996 options, 15,000 are 100% vested as of the date of grant and 25,000 are 100% vested at the first anniversary of the date of grant. The Company granted 39,769 options in 1995 and 40,000 in 1996. In accordance with APB 25, the Company has not recognized any compensation cost for the Stock Options granted in 1995 and 1996. F-16 9. Stock Options and Warrants, continued: A summary of the status of the Company's stock options as of December 31, 1996, 1995, and 1994 and the changes during the yaer ended on that date is presented below:
1996 1995 1994 ---- ---- ---- Number of Weighted Number of Weighted Number of Weighted Shares Average Shares Average Shares Average Underlying Exercise Underlying Excercise Underlying Exercise Options Prices Options Prices Options Prices ------- ------ ------- ------ ------- ------ Outstanding at begining of the year 55,216 $4.36 31,713 $5.27 26,713 $ .53 Granted 40,000 $3.59 39,769 $3.13 10,000 $4.68 Exercised 7,924 $2.99 16,266 $3.13 -- -- Forfeited -- -- -- -- -- -- Expired -- -- -- -- 5,000 $4.45 Outstanding at end of year 87,292 $4.13 55,216 $4.36 31,713 $5.27 Exercisable at end of year 62,292 $4.28 55,216 $4.36 31,713 $5.27 Weighted-average Fair Value of options $1.15 $1.79 N/A granted during the year
The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions for grants in 1996 and 1995, respectively: dividend yield of 0.00% for both years; expected volatility of 48.85% for both years; risk-free interest rates are from 5.37% to 7.76% and the expected lives of the options are 5 years for 1996 grants and 2.5 years for 1996 grants and 2.5 years for 1995 grants. The following table summarizes information about stock options outstanding at December 31, 1996:
Options Outstanding Options Exercisable ------------------- ------------------- Weighted Average Remaining Weighted Weighted Range of Number Contractual Average Number Average Excercise Prices Outstanding Life Excercise Price Excercisable Excercise Price - ---------------- ----------- ---- --------------- ------------ --------------- $2.34 to $5.00 74,095 5.62 $3.72 46,095 $3.70 $5.01 to $7.22 13,197 0.74 $6.42 13,197 $6.42 - ------------------------------------------------------------------------------------------------- $2.34 to $7.22 87,292 4.88 $4.13 62,291 $4.28
Had the compensation cost for the Company's stock-based compensation plans been determined consistent with SFAS 123, the Company's net income per common share for 1996 and 1995 would approximate the pro forma amounts below: 1996 1995 ---- ---- As Reported Pro Forma As Reported Pro Forma ----------- --------- ----------- --------- SFAS 123 Charge -- $59,189 -- $45,713 APB 25 Charge -- -- -- -- Net Income $1,697,987 $1,642,519 $886,886 $856,593 Net Income Per Common Share $0.32 $0.30 $0.27 $0.26 The effects of applying SFAS 123 in this pro forma disclosure are not indicative of future amounts. SFAS does not apply to awards prior to 1995. 10. Financial Instruments With Off-Balance-Sheet Risk and Concentration of Credit Risk: The Bank is party to financial instruments with off-balance-sheet risk, entered into in the normal course of business to meet the financing needs of its customers. These financial instruments include loan commitments and letters of credit. The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the financial statements. F-17 10. Financial Instruments With Off-Balance-Sheet Risk and Concentrations of Credit Risk, continued: The Bank's exposure to credit loss in the event of nonperformance by counterparties to loan commitments and letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as are used in underwriting on-balance sheet instruments. The total amounts of financial instruments with off-balance sheet risk at December 31, 1996 and 1995 are as follows: December 31, ------------------------- 1996 1995 ---- ---- Unfunded loan commitments $3,721,000 $3,289,000 Letters of credit 255,000 409,000 Since many of the loan commitments may expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. Loans are made in accordance with formal written loan policies. The Bank evaluates each customer's creditworthiness on a case by case basis. The amount of collateral obtained, if deemed necessary by the Bank, upon extension of credit is based on management's evaluation of the counterparty. Collateral held varies, but may include cash, accounts receivable, inventory, property, equipment and real estate. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank had certificates of deposit, or other deposit accounts, in the amount of $220,500 and $230,500 at December 31, 1996 and 1995, respectively, as collateral supporting those letter of credit commitments for which collateral is deemed necessary. The Bank sold $16,772,000, $18,490,000, and $7,265,000 in federal funds at December 31, 1996, 1995 and 1994, respectively. These funds represent uncollateralized loans made by the Bank, in varying amounts, to commercial banks with whom the Bank has correspondent relationships. The Bank maintains deposits with other financial institutions in amounts which exceed FDIC insurance coverage. The Bank has not experienced any losses in such accounts and believes it is not exposed to any significant credit risks on cash and cash equivalents. The Bank has geographic concentrations of credit in its principal trade areas of Angelina, Cherokee, Ellis, Grayson, Houston, Tarrant and Tyler Counties, Texas. Additionally, the Bank has a significant concentration of credit, based upon like collateral, in its insurance premium finance portfolio. Insurance premium finance comprises approximately $39,169,000 or 37% and $22,409,000 or 33% of consolidated total loans as of December 31, 1996 and 1995, respectively. 11. Related Party Transactions: In the ordinary course of business, loans have been granted to directors, executive officers and employees. Loans to these related parties total approximately $398,000, and $428,000 as of December 31, 1996 and 1995, respectively. 12. Net Income Per Common Share: Net income per common share for the year ended December 31, 1996, 1995, and 1994 was based upon 5,389,366, 3,279,448, and 2,393,841 weighted average shares of common stock outstanding, respectively. The effects of the exercise of stock options and warrants are not material and have not been considered in the calculation of income per common share. F-18 13. Employee Benefit Plan: Effective October 1, 1993 the Company adopted the Surety Bank 401(k) Plan (the "Plan"). All full-time employees are eligible for participation. Under the terms of the Plan, eligible employees are allowed to contribute up to 10% of their gross pay. The Company contributes amounts equal to a maximum of 2.5% of the employee's gross wages, subject to statutory limits. The expense and employer contribution for the Plan for the years ended December 31, 1996, 1995 and 1994 was $85,886, $88,982, and $58,745, respectively. 14. Federal Income Tax: The components of the net deferred asset/(liability) recognized at December 31, 1996 and 1995 are as follows: December 31, December 31, 1996 1995 ------------ ------------ Deferred tax liability: Depreciation and amortization $(463,817) $(299,557) Securities (1,011) (34,286) Deferred loan costs (63,050) (46,819) Other (830) (52,750) Net unrealized gain on available-for-sale investment securities (73,091) ---------- ---------- (528,708) (506,503) Deferred tax asset: Net unrealized loss on available-for-sale investment securities 8,056 Tax net operating losses 35,326 40,373 Depreciation 24,878 31,620 Allowance for credit losses 194,274 145,080 Securities 59,409 50,088 Other 27,183 27,397 Other real estate losses 61,155 ---------- ---------- 410,281 294,558 ---------- ---------- Net deferred tax asset/(liability) $(118,427) $(211,945) ========== ========== The Company's effective tax rate on income before income taxes differs from the U.S. statutory tax rate as follows: December 31, -------------------------------- 1996 1995 1994 ---- ---- ---- U.S. statutory rate 34.0% 34.0% 34.0% Other .9 1.7 Goodwill 4.4 4.2 Valuation allowance (33.0) Tax-exempt interest (3.7) (6.2) (1.1) ------ ------ ------ Effective tax rate 35.6% 33.7% (.1)% ==== ==== === F-19 14. Federal Income Tax, continued: As of December 31, 1996, the Company has a net operating loss carryforward of approximately $104,000 for income tax reporting purposes which expires, if not used, in 2002 through 2004. The utilization of this net operating loss carryforward is limited by Section 382 of the Internal Revenue Code to approximately $15,000 annually until its expiration. The comprehensive provision for federal income taxes for the years ended December 31, 1996, 1995 and 1994 consists of the following:
December 31, --------------------------------------------- 1996 1995 1994 ---- ---- ---- Current: Federal $916,674 $247,359 $18,430 State 33,826 15,648 18,267 ----------- ----------- ----------- 950,500 263,007 36,697 ----------- ----------- ----------- Deferred: Federal (12,372) 187,924 (19,009) State ----------- ----------- ----------- (12,372) 187,924 (19,009) ----------- ----------- ----------- Provision for tax expense charged to results of operations 938,128 450,931 17,688 Tax expense charged to goodwill 86,706 Tax on unrealized gain on available-for-sale securities (81,147) 73,092 ----------- ----------- ----------- Comprehensive provision for federal income taxes $856,981 $610,729 $17,688 =========== =========== ===========
15. Other Noninterest Income and Expense: Other noninterest income for the years ended December 31, 1996, 1995 and 1994 was composed of the following:
1996 1995 1994 ------------ ----------- ----------- Noninterest Income: Nonsufficient fund charges $ 460,156 $291,954 $263,315 Late fee charges 681,644 501,960 426,476 Service charges 372,756 220,086 163,336 Collection fees 135,533 115,478 96,162 Credit life insurance 57,509 75,435 44,402 Secured credit card annual fee 4,447 6,561 15,905 Other 165,409 207,593 150,411 ------------ ----------- ----------- Total $1,877,454 $1,419,067 $1,160,007 ============ =========== ===========
F-20 15. Other Noninterest Income and Expense, continued: Other noninterest expense for the years ended December 31, 1996, 1995 and 1994 was composed of the following: 1996 1995 1994 ----------- ----------- ----------- General and administrative expense: Professional fees $467,662 $416,006 $315,434 Office supplies 386,114 253,542 201,028 Travel and entertainment 96,577 68,987 60,162 Telephone 283,564 166,858 128,407 Advertising 174,335 104,499 54,683 Postage 299,388 230,807 133,887 Amortization of intangibles 359,717 184,332 51,201 Dues and subscriptions 70,559 49,331 54,609 Insurance 167,245 130,335 97,473 Credit cards 7,472 19,868 59,573 Bank service charge 110,881 57,196 25,808 FDIC assessment 3,553 123,310 133,112 Credit reports 22,850 40,105 17,714 Other 195,670 202,972 257,723 ----------- ----------- ----------- $2,645,587 $2,048,148 $1,590,814 ========== ========== ========== 16. Commitments and Contingencies: As of December 31, 1996 the Company leased its office space in Hurst, Texas under a noncancellable operating lease. The lease expires December 31, 1999. Future minimum lease payments are as follows: For the years ending: ---------- 1997 $138,865 1998 131,068 1999 136,696 -------- Total $406,629 ======== Rent expense was $161,862 for the year ended December 31, 1996, $94,713 for the year ended December 31, 1995 and $83,062 for the year ended December 31, 1994. The Company has entered into change in control agreements with certain of its executive officers. The change in control agreements provide for the payment under certain circumstances of benefits to these executive officers in the event of a change in control of the Company followed by the termination of employment of the officers. A "change in control" is deemed to have occurred if (i) any person becomes the beneficial owner, directly or indirectly, of twenty percent (20%) or more of the Common Stock of the Company, or (ii) during any period of two (2) consecutive years during the term of the change in control agreements, individuals who at the beginning of such period constitute the Board of Directors cease for any reason to constitute at least a majority thereof, unless the election of each director who was not a director at the beginning of such period has been approved in advance by directors representing at least 66 2/3% of the directors then in office who were directors at the beginning of the period. F-21 16. Commitments and Contingencies, continued: Under the change in control agreements, officers who, during the period commencing on the effective date of a change of control and ending two (2) years thereafter, are terminated by the Company for any reason other than for cause or who terminate their employment with the Company with good reason are entitled to receive a change in control payment at the time of such termination. The change in control payment payable under the change in control agreements may, at the election of the officers, be either in the form of a lump sum cash payment or in the form of Common Stock of the Company. The amount of the lump sum cash payment is equal to each officer's annual base salary rate (but excluding all other compensation, such as bonuses and fringe benefits) in effect immediately before the effective date of the change in control, multiplied by three (3). The stock payment consists of shares of Common Stock of the Company in an amount equal to the result obtained by dividing the cash payment the officer would otherwise be entitled to receive by the market value of the Common Stock on the effective date of the change in control. The change in control agreements continue in effect through September 1, 1997. On each successive September 1, the terms of the change in control agreements will be automatically extended for one (1) additional year, unless not later than by December 31 of the preceding year the Company shall have given notice to the officers that it does not wish to extend such change in control agreements. The Bank is a defendant in two related cases: Tennessee Ex Rel. Douglas Sizemore, Commissioner of Commerce and Insurance for the State of Tennessee, et al. vs. Surety Bank, N.A., filed in June 1995 in the Federal District Court for the Northern District of Texas, Dallas, Division (the "Anchorage Case"), and United Shortline Inc. Assurance Services, N.A. et al. vs. MacGregor General Insurance Company, Ltd., et al., now pending in the 141st Judicial District Court of Tarrant County, Texas (the "MacGregor Case"). The claimant in the Anchorage Case is the Tennessee Commissioner of Commerce and Insurance ("Tennessee"), appointed by the Chancery Court for the State of Tennessee, Twentieth Judicial District, Davidson County, to liquidate Anchorage Fire and Casualty Insurance Company ("Anchorage"), including Anchorage deposits at the Bank. Tennessee seeks to recover compensatory and punitive damages on various alleged causes of action, including violation of orders issued by a Tennessee court, fraudulent and preferential transfers, common law conversion, fraud, negligence, and bad faith, all of which are based on the same underlying facts and course of conduct. The plaintiff in the MacGregor Case, United Shortline Inc. Assurance Services, N.A. ("Shortline"), is the holder of a Florida judgment against MacGregor General Insurance Company, Ltd. ("MacGregor") who seeks to recover funds allegedly belonging to MacGregor which were held by the Bank. Both cases arise out of the Bank's alleged exercise of control over funds, representing the Bank's collateral, held in accounts at the Bank under agreements with Anchorage and MacGregor. The Bank asserts that it had a right to exercise control over its collateral under contractual agreements between the Bank and the respective insurance companies or the Bank and the policy holders, and also in order to protect the Bank against the possibility of inconsistent orders regarding the same funds. Tennessee also seeks to recover funds allegedly transferred in and out of the Anchorage/MacGregor accounts at the Bank during an approximate four month period in 1993. When the MacGregor case was initially filed, Shortline sought a restraining order against the Bank concerning the MacGregor funds. When the Bank received notice of competing claims to some or all of these funds by Tennessee, the Bank intervened and interpled approximately $600,000 into the court's registry. Shortline now seeks, inter alia, damages against the Bank from an alleged wrongful offset wherein the Bank allegedly exercised control over the MacGregor funds at the Bank pursuant to agreements with MacGregor. The Bank moved for and obtained a summary judgment that its intervention and interpleader of funds was proper. Shortline also sought and obtained a summary judgment from the trial court that the funds interpled by the Bank into the court's registry belonged to Shortline. Tennessee appealed the summary judgment to the Fort Worth Court of Appeals. The Fort Worth Court of Appeals affirmed the trial court's ruling that the Bank's intervention and interpleader was proper but reversed the trial court's ruling that the funds in the court belonged to Shortline. Currently, Shortline and Tennessee have made application to the Texas Supreme Court to allow an appeal of the ruling from the Fort Worth Court of Appeals. F-22 16. Commitments and Contingencies, continued: In the Anchorage case, Tennessee claims that the Bank allegedly transferred funds in and out of the Anchorage accounts after allegedly receiving notice of court orders prohibiting such transfers. Discovery in this case is in the initial stages and the damages sought by Tennessee are not yet certain. The Bank believes both of these cases lack merit and intends to defend them vigorously. The outcome of both of these cases is uncertain at this time. 17. Regulatory Matters: The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory-possibly additional discretionary-actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators regarding components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined in the regulations), and of Tier I capital (as defined) to average total consolidated assets (as defined in the regulations) also known as the leverage ratio. Management believes, as of December 31, 1996, that the Bank has met all capital adequacy requirements to which it is subject. As of September 30, 1996, the most recent notification from the Office of the Comptroller of the Currency categorized the Bank as adequately capitalized under the regulatory framework for prompt corrective action. To be categorized as adequately capitalized the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed the Bank's category. The Bank's actual capital amounts and ratios are presented in the table for the years ended December 31, 1996 and 1995.
Minimum Well- Capital Capitalized December 31, Ratios Ratios -------------------------- ------------------------------ 1996 1995 ---- ---- Tier I risk-based capital $12,013,000 $7,964,000 Tier II risk-based capital 1,285,000 703,000 Total capital 13,298,000 8,667,000 Risk-weighted assets 108,208,000 73,983,000 Capital ratios: Tier I risk-based capital 11.10% 10.76% 4.00% 6.00% Tier II risk-based capital 12.29 11.72 8.00 10.00 Leverage ratio 7.02 6.88 4.00 5.00
F-23 17. Fair Value of Financial Instruments: Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. For variable-rate loans that reprice frequently with no significant change in credit risk, fair values are based on carrying values. The fair values of other loans are estimated using discounted cash flow analysis, which utilize interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. The fair values of noninterest and interest-bearing demand deposits are, by definition, equal to the amount payable on demand, i.e., their carrying amount. The fair values of interest-bearing time deposits are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates of similar maturities. The carrying amounts for cash and due from banks, federal funds sold, accrued interest receivable, notes payable and accrued interest payable approximate the fair values of such assets and liabilities. Fair values for the Company's off-balance sheet instruments, which consist of lending commitments and standby letters of credit, are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing. Management believes the value of these off-balance sheet instruments are not materially different from the commitment amount.
At December 31, 1996 At December 31, 1995 -------------------- -------------------- Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value ------ ---------- ------ ---------- (in Thousands) (in Thousands) Financial Assets: Cash and interest bearing liabilities $ 6,094 $6,094 $5,773 $5,773 Federal funds sold 16,772 16,772 18,490 18,490 Available-for-sale securities 16,221 16,221 10,128 10,128 Held-to-maturity securities 22,561 22,763 13,781 14,078 Loans receivable 101,867 101,298 66,399 66,499 Accrued interest receivable 1,083 1,083 781 781 Financial Liabilities: Noninterest bearing deposits 23,879 23,879 13,183 13,183 Interest bearing deposits 131,811 131,845 96,416 96,444 Other short-term borrowings 375 375 Accrued interest payable 1,518 1,518 520 520 Off-balance sheet instruments 2,550 2,550 3,698 3,698
F-24 19. Parent Company Financial Information: Condensed Parent Company Only Statements of Condition as of December 31, 1996 and 1995
December 31, December 31, 1996 1995 ------------- ------------ Assets: Cash $ 756,813 $ 59,525 Receivable from subsidiary 103,760 67,998 Investment in subsidiary, at equity 18,318,004 10,493,698 Other assets 51,975 107,057 ----------- ----------- Total assets $19,230,552 $10,728,278 =========== =========== Liabilities: Note payable - $ 375,000 Accrued liabilities - 58,806 ----------- ----------- Total liabilities - 433,806 ----------- ----------- Shareholders' equity: Common stock $ 57,637 $ 35,166 Additional paid-in capital 16,752,003 9,356,469 Retained earnings 2,509,771 811,784 Treasury stock (74,539) (50,830) Unrealized (loss) gain on available-for-sale securities (14,320) 141,883 ----------- ----------- Total shareholders' equity 19,230,552 10,294,472 ----------- ----------- Total liabilities and shareholders' equity $19,230,552 $10,728,278 =========== ===========
F-25 19. Parent Company Financial Information, continued: Condensed Parent Company Only Statements of Income for the years ended December 31, 1996, 1995 and 1994
December 31, ---------------------------------------------------- 1996 1995 1994 --------------- -------------- --------------- Interest income $40,045 $7,395 $24,685 Interest expense 6,612 122,579 11,075 --------------- -------------- --------------- Net interest income (expense) before provision for credit loss 33,433 (115,184) 13,610 Recovery on credit loss 3,101 --------------- -------------- --------------- Net interest income/(expense) 33,433 (115,184) 16,711 Noninterest expense (169,610) (230,252) (207,473) Equity in net income of subsidiary 1,788,489 1,140,603 390,797 --------------- -------------- --------------- Net income before income taxes 1,652,312 795,167 200,035 Income tax (benefit) expense: Current (45,675) (120,612) (242,493) Deferred 28,893 (30,232) --------------- -------------- --------------- Net income $ 1,697,987 $ 886,886 $ 472,760 =============== ============== ===============
F-26 19. Parent Company Financial Information, continued: Condensed Parent Company Only Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994
December 31, ----------------------------------------- 1996 1995 1994 ----------- ----------- ----------- Cash flows from operating activities: Net income $ 1,697,987 $ 886,886 $ 472,760 Adjustments to reconcile net income to Net cash used in operating activities: Net increase in receivable from subsidiary (35,762) 174,495 (242,493) Equity in net income of subsidiary (1,810,509) (1,137,764) (393,636) Net decrease (increase) in deferred tax asset 30,232 (30,232) Net (decrease) increase in other assets 55,082 (86,057) (21,000) Net (decrease) increase in accrued liabilities (58,806) 44,892 13,914 ----------- ----------- ----------- Net cash used in operating activities (209,814) (87,316) (200,687) ----------- ----------- ----------- Cash flows from investing activities: Proceeds from the maturity of interest 450,000 Investment of subsidiary (6,170,000) (5,000,000) ----------- ----------- ----------- Net cash used in investing activities (6,170,000) (4,550,000) ----------- ----------- ----------- Cash flows from financing activities: Sale of common stock 7,394,293 1,197,182 2,314,772 Short-term debt 1,750,000 Exercise of stock options 23,712 50,831 Payments on borrowings (375,000) (1,375,000) Purchase of treasury stock (23,709) (50,830) ----------- ----------- ----------- Net cash provided by (used in) financing activities 7,077,102 (177,817) 4,064,772 Net increase (decrease) in cash and cash equivalents 697,288 (265,133) (685,915) Beginning cash and cash equivalents 59,525 324,658 1,010,573 ----------- ----------- ----------- Ending cash and cash equivalents $ 756,813 $ 59,525 $ 324,658 =========== =========== ===========
F-27 INDEX TO EXHIBITS Exhibit Number Exhibit - ------------------------------------------------------------------------------- 10.13 Executive Deferred Compensation Agreement and related Adoption Agreement with Designation of Beneficiaries entered into between Surety Capital Corporation and B. J. Curley, dated January 21, 1997 10.14 Letter Agreement between Surety Capital Corporation and B. J. Curley regarding provision by Surety Capital Corporation of term life insurance coverage, dated January 21, 1997 10.15 Surety Capital Corporation Amended and Restated Stock Option Plan for Directors, and Form of Stock Option Agreement 21 Subsidiaries of the Registrant 23 Consent of Coopers & Lybrand L.L.P. 24 Special Power of Attorney 27 Financial Data Schedule EX-10.13 2 EXECUTIVE DEFERRED COMPENSATION AGREEMENT EXHIBIT 10.13 EXECUTIVE DEFERRED COMPENSATION AGREEMENT BETWEEN SURETY CAPITAL CORPORATION AND B. J. CURLEY This Agreement ("Agreement") is entered into by Surety Capital Corporation, a Delaware corporation (the "Corporation"), and B. J. Curley ("Curley"). The Corporation and Curley are collectively referred to as the "Parties." In consideration of the mutual covenants set forth below, it is agreed as follows: 1. PURPOSE. The purpose of this Agreement is to assist the Corporation in attracting and retaining in its employ executives of outstanding competence by providing such executives with an economic incentive to continue their employment with the Corporation. 2. DEFINITIONS. For purposes of this Agreement, the following terms shall have the following meanings: (a) "Cause" shall mean any act that is materially adverse to the best interests of the Corporation and constitutes, on the part of Curley, common law fraud, a felony or other gross malfeasance of duty. (b) "Change in Control" shall be deemed to have occurred if (A) any "person" (as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended, the "Exchange Act"), other than a trustee or other fiduciary holding securities under an employee benefit plan of the Corporation, is or becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Corporation representing twenty percent (20%) or more of the combined voting power of the Corporation's then outstanding voting securities; or (B) during any period of two (2) consecutive years during the term of this Agreement, individuals who at the beginning of such period constitute the Board of Directors of the Corporation cease for any reason to constitute at least a majority thereof, unless the election of each director who was not a director at the beginning of such period has been approved in advance by directors representing at least two-thirds (2/3rds) of the directors then in office who were directors at the beginning of the period. (c) "Disability" shall mean the inability of Curley to manage the Corporation's property, business or financial affairs by reason of illness, infirmity, insanity, mental incompetency or otherwise, determined to be (or reasonably expected to be, based upon then available medical information) of not less than twelve (12) calendar months' duration. The initial determination (or reasonable expectancy) shall be determined by the opinion of the Physician (defined as a person licensed to practice medicine in Texas) regularly attending Curley. If the Corporation's Board of Directors (the "Corporation's Board") disagree with the Physician's opinion, or if Curley has not engaged a Physician, the Corporation's Board may engage at the Corporation's expense a Physician to examine Curley, and Curley consents to such examination and to waive, if applicable, any privilege between the Physician and Curley that may arise as a result of said examination. If Curley has not engaged a Physician, the opinion of the Physician engaged by the Corporation's Board shall control. If Curley has engaged a Physician, and if, after conferring, Curley's Physician and the Corporation's Physician cannot agree on a final opinion, they shall within thirty (30) days thereafter choose a third consulting Physician whose opinion shall control. The expense of the third consulting Physician shall be borne equally by Curley and the Corporation. (d) "Good Reason" shall mean: (1) a material reduction of Curley's duties, responsibilities and status with the Corporation as they existed immediately before the effective date of a Change in Control; (2) a reduction of Curley's base salary from that in effect immediately before the effective date of a Change in Control; or (3) Curley's relocation to offices of the Corporation more than thirty (30) miles from the location of the Corporation's principal offices immediately before the effective date of a Change in Control. 3. Amount of Deferral. Subject to the limitations set forth in this Agreement, Curley shall be entitled to deferred compensation payments on his continuing employment with the Corporation until he reaches age sixty-five (65) or at such earlier age as provided for in this Agreement. Although the varying amounts payable to Curley as deferred compensation in the event of a termination of his employment prior to his reaching age sixty-five (65) are set forth in this Agreement, no funds or other property shall be set aside for the payment of any amounts due to Curley. Curley's rights are limited to the rights to receive payments as provided under this Agreement, and his position with respect thereto is that of a general, unsecured creditor of the Corporation. (a) Deferral Amount at Age Sixty-Five. On Curley's reaching age sixty-five (65) and his employment by the Corporation not having been terminated as provided for in subsections (b) and (c) below prior to such date, he shall be entitled to, and the Corporation agrees to pay, payments equaling Twenty-Five Thousand and No/100 Dollars ($25,000.00) per year for a period of fifteen (15) years. Curley shall be entitled to the payments without regard to whether he continues in the employment of the Corporation after age sixty-five (65). (b) Deferral Amount Prior to Age Sixty-Five - Employment Termination Due to Change in Control, Disability, by Death, or For Reasons Other than for Cause. If Curley's employment by the Corporation is terminated prior to his reaching age sixty-five (65): (1) for any reason other than for Cause (as herein defined) during the period commencing with the effective date of a Change in Control and ending two (2) years thereafter, (2) by Curley with Good Reason (as herein defined) during the period commencing with the effective date of a Change in Control and ending two (2) years thereafter, (3) as a result of the Disability (as herein defined) of Curley, (4) as a result of the death of Curley, or (5) for any other reason other than Cause he shall be entitled to a single payment either in the amount of the then cash surrender value of that certain $300,000 universal key man life insurance policy on the life of Curley (Policy Number A10161400L issued by American General Life Insurance Company and owned by the Corporation) or, in the event such life insurance policy is no longer then in effect, in the amount set forth on Exhibit A to this Agreement. (c) Deferral Amount Prior to Age Sixty-Five - For Cause Employment Termination. If Curley's employment by the Corporation is terminated for Cause prior to his reaching age sixty-five (65), he shall not be entitled to any amounts under this Agreement, and the Corporation's obligations under this Agreement shall terminate on the date of termination of Curley's employment. -2- 4. Payment Procedures for Deferred Amounts. (a) Deferral Payments at Age Sixty-Five. If the deferred compensation payable to Curley is determined under the provisions of Section 3(a), the first installment of the annual deferred compensation amount of Twenty-Five Thousand and No/100 Dollars ($25,000.00) shall be paid to him on or before thirty (30) days following his reaching age sixty-five (65), and the fourteen successive annual installments shall be paid to him on or before the annual anniversary date of the first installment. (b) Deferral Payments Prior to Age Sixty-Five. (1) If Curley's employment by the Corporation is terminated under the provisions of Section 3(b), the payment amount as determined pursuant to Section 3(b) shall be paid to Curley within ninety (90) days after the termination of his employment, and such payment shall terminate all obligations of the Corporation under this Agreement. (2) If Curley's employment by the Corporation is terminated under the provisions of Section 3(c), no payment shall be owed to Curley, and the Corporation's obligations under this Agreement shall terminate on the effective date of Curley's termination of employment. (c) Party to Receive Payment. All payments owed under this Agreement shall be made to Curley or, in the event of Curley's death, to the beneficiary designated by Curley or to Curley's estate in the event he does not designate a beneficiary. Curley shall have the right to designate a beneficiary to receive any payments under this Agreement which may remain unpaid at the time of his death. The designation shall be delivered in writing to the Corporation's Board. The designation may be changed by Curley at any time in a similar manner without the consent of any prior designated beneficiary. If no designation of a beneficiary is delivered by Curley to the Corporation's Board, any payments remaining unpaid at the time of the Curley's death shall be paid to his estate at such time and in such manner as if he had remained living. If in the judgment of the Corporation's Board Curley or his beneficiary is legally, physically or mentally incapable of personally receiving any payments due under this Agreement, the payment shall be made to the guardian or other legal representative of Curley or his beneficiary, or to such other person or institution who in the opinion of the Corporation's Board is then maintaining or has custody of Curley or the beneficiary. Payment shall constitute a full discharge with respect to such benefits. 5. Insurance. To provide a fund with which to pay any amounts owed under this Agreement, the Corporation may (but shall not be obligated to) apply for insurance on Curley's life. The Corporation shall be the owner and beneficiary of any such insurance policy, and it may discontinue the insurance coverage at any time without any obligation to obtain replacement insurance. Curley agrees to submit to such reasonable physical examinations and to provide any information as may be necessary in connection with the purchase of such insurance. The Corporation shall collect all proceeds or termination value of the insurance, if any, and may (but shall not be obligated to) apply the proceeds toward the payment of any amounts owed under this Agreement. Any insurance policy owned by the Corporation on Curley's life, and the proceeds or termination value of such policy, shall not be encumbered or otherwise restricted by the Corporation's obligations under this Agreement, except to the extent such policy or proceeds are the general assets of the Corporation. If Curley's employment by the Corporation is terminated for any reason other than his death and the Corporation then owns a life insurance policy on his life, the Corporation agrees that, if permitted by the issuing company and not prohibited by any agreement or limitation to which the Corporation may then subject, Curley may acquire the life insurance policy from the Corporation for the lesser of: (1) the then cash surrender value -3- of the policy, or (2) the total premium payments made by the Corporation with respect to the policy prior to such date (as same is determined by the issuing company). 6. Restrictions. No right or benefit under this Agreement shall be subject to anticipation, alienation, sale, assignment, pledge, encumbrance, or charge and any such actions shall be void. No right or benefit under this Agreement shall in any manner be liable for or subject to the debts, contracts, liabilities, or torts of the person entitled to such benefits. If Curley or a beneficiary of Curley should become bankrupt or attempt to anticipate, alienate, sell, assign, pledge, encumber, or charge any right to a benefit under this Agreement, the right or benefit shall automatically terminate as to Curley or the beneficiary; but, in such event, Corporation may hold or apply the same or any part thereof for the benefit of Curley's spouse, children, or other dependents or any of them, in such manner and in such portion as the Corporation's Board may deem proper in its sole discretion. 7. Unsecured Promise. This Agreement shall create only an unfunded, unsecured promise by the Corporation to pay the benefits provided herein. Curley does not have, nor will Curley have, any claim, by means of a security or collateral interest or otherwise, to any of the assets of the Corporation, the same being owned solely by the Corporation. 8. Adjustment to Payment Amount. The deferred compensation amount payable to Curley under this Agreement, if any, shall be reduced by any amounts Curley owes the Corporation. These amounts may include, but are not limited to, amounts owed by Curley for loans, advances, and expense reimbursements. 9. Continuation of Employment. Neither this Agreement nor Curley's right to receive payment of any benefits under this Agreement shall be construed as giving Curley any right to be retained as an employee of the Corporation. 10. Invalid Provision. In the event any of the provisions, or portions thereof, of this Agreement are held to be invalid, illegal or unenforceable by any court of competent jurisdiction, the validity, legality and enforceability of the remaining provisions, or portions thereof, shall not be affected. Moreover, so far as is reasonable and possible, effect shall be given to the intent manifested by the portion held invalid, illegal, or unenforceable. 11. Construction. (a) Form and Gender. Whenever required by the context in which it is used, the singular number shall include the plural, and the plural number shall include the singular. In like manner, the masculine gender shall include the feminine, and the feminine gender shall include the masculine. (b) Captions. The captions or headings in this Agreement are made for convenience and general reference only and shall not be construed to describe, define, or limit the scope or intent of the provisions of this Agreement. 12. Governing Law. This Agreement has been executed in and shall be governed by the laws of the State of Texas. The Parties agree that the terms of this Agreement shall be performed and all legal proceedings involving this Agreement shall be conducted in Tarrant County, Texas. -4- 13. Inurement. This Agreement shall extend to and be binding upon Curley and his heirs, legatees, legal representatives, and successors, and on the Corporation, its successors or assigns. The rights of Curley under this Agreement may not be assigned. 14. Amendment. All amendments or changes to this Agreement shall be in writing. 15. Counterparts. This Agreement may be executed in multiple counterparts, each of which shall be an original Agreement. All counterparts together shall represent but one and the same instrument. The counterpart executed and held in the Corporation's corporate minute book shall control in the event of any dispute or in cases of difference between the counterparts. 16. Further Assurances. Each party to this Agreement agrees to perform any further acts and to execute and deliver any documents or legal instruments which may be reasonably necessary to carry out the provisions of this Agreement. Each party also agrees not to enter into any Agreement or contract with others that will tend to alter, amend, abrogate or in any way adversely affect the provisions of the Agreement. 17. Entire Agreement. This Agreement contains the entire understanding between the undersigned concerning the subject matter of the Agreement. There are no other representations, agreements, arrangements, or understandings, oral or written, between or among the parties, relating to the subject matter of this Agreement, which are not fully expressed herein. 18. Authorization. The Corporation is authorized to enter into this Agreement by virtue of resolutions duly adopted by Corporation's Board. 19. Effective Date. The effective date of this Agreement is January 21, 1997. SURETY CAPITAL CORPORATION By: /s/ C. Jack Bean /s/ B. J. Curley - ---------------------- ---------------- Name: C. Jack Bean B. J. Curley Title: Chairmal of the Board -5- EXHIBIT A to EXECUTIVE DEFERRED COMPENSATION AGREEMENT BETWEEN SURETY CAPITAL CORPORATION AND B. J. CURLEY Age on Date of Section 3(b) Payment Employment for Termination Termination of Agreement 34 $ 1,334.00 ----------- 35 $ 2,757.00 ----------- 36 $ 4,275.00 ----------- 37 $ 5,894.00 ----------- 38 $ 7,620.00 ----------- 39 $ 9,506.00 ----------- 40 $ 12,276.00 ----------- 41 $ 15,462.00 ----------- 42 $ 18,837.00 ----------- 43 $ 22,375.00 ----------- 44 $ 26,239.00 ----------- 45 $ 30,314.00 ----------- 46 $ 34,664.00 ----------- 47 $ 39,301.00 ----------- 48 $ 44,901.00 ----------- 49 $ 50,907.00 ----------- 50 $ 57,108.00 ----------- 51 $ 63,939.00 ----------- 52 $ 70,931.00 ----------- 53 $ 78,325.00 ----------- 54 $ 85,564.00 ----------- 55 $ 93,279.00 ----------- 56 $ 101,496.00 ----------- 57 $ 110,257.00 ----------- 58 $ 119,612.00 ----------- 59 $ 129,628.00 ----------- 60 $ 140,368.00 ----------- 61 $ 151,872.00 ----------- 62 $ 164,260.00 ----------- 63 $ 177,620.00 ----------- 64 $ 192,043.00 ----------- SURETY CAPITAL CORPORATION 1845 Precinct Line Road, Suite 100 Hurst, Texas 76054 January 21, 1997 Mr. B. J. Curley Surety Capital Corporation 1845 Precinct Line Road, Suite 100 Hurst, Texas 76054 Re: Executive Deferred Compensation Agreement Between Surety Capital Corporation and B. J. Curley Dear Bud: A copy of your Executive Deferred Compensation Agreement (the "Agreement") with Surety Capital Corporation ("Surety") is attached for your review and records. This Agreement has been approved by the Board of Directors of Surety, and it contains the entire agreement between yourself and Surety with regard to all deferred compensation benefits previously discussed with you. If the Agreement is acceptable to you, please sign the enclosed copy of this letter and return the signed copy to my attention. Also, please complete, sign, have notarized, and return the enclosed beneficiary designation form. Your signature on the enclosed letter and your completion of the beneficiary designation form will complete the paperwork for the Agreement. If any questions arise, please do not hesitate to let me know. Sincerely, /s/ C. Jack Bean C. Jack Bean, Chairman Agreed and Accepted Effective January 21, 1997 By: /s/ B. J. Curley B. J. Curley Attachments: Beneficiary Designation Form Executive Deferred Compensation Agreement DESIGNATION OF BENEFICIARY TO: Surety Capital Corporation Board of Directors FROM: B. J. Curley Pursuant to Section 4(c) of the Executive Deferred Compensation Agreement Between B. J. Curley and Surety Capital Corporation (the "Agreement") permitting the designation of a beneficiary or beneficiaries by myself for benefits payable under the Agreement, I hereby designate the following person or persons as primary and secondary beneficiaries of any amounts under the Agreement payable by reason of my death: Primary Beneficiary Name:____________________________________________ Address:_________________________________________ _________________________________________ Social Security Number:__________________________ Relationship:____________________________________ Secondary Beneficiary Name:____________________________________________ Address:_________________________________________ _________________________________________ Social Security Number:__________________________ Relationship:____________________________________ I RESERVE THE RIGHT TO REVOKE OR CHANGE ANY BENEFICIARY DESIGNA- TION. I HEREBY REVOKE ALL PRIOR DESIGNATIONS (IF ANY) OF PRIMARY BENEFICIARIES AND SECONDARY BENEFICIARIES. All sums payable under the Agreement by reason of my death shall be paid to my primary beneficiary, if he or she survives me. If no primary beneficiary survives me, the sums shall be paid to the secondary beneficiary. If none of the named beneficiaries survive me, any amounts payable under the Agreement shall be paid in accordance with the provisions of the Agreement. --------------- B. J. Curley STATE OF TEXAS COUNTY OF TARRANT This instrument was acknowledged before me on _______________, 1997 by B. J. Curley. ------------------------------------------- Notary Public in and for the State of Texas EX-10.14 3 LEVEL TERM LIFE INSURANCE EXHIBIT 10.14 SURETY CAPITAL CORPORATION 1845 Precinct Line Road, Suite 100 Hurst, Texas 76054 January 21, 1997 Mr. B. J. Curley Surety Capital Corporation 1845 Precinct Line Road, Suite 100 Hurst, Texas 76054 Re: Level Term Life Insurance Dear Bud: We have previously discussed Surety Capital Corporation ("Surety") providing life insurance coverage for you during the period you are an employee of Surety, and this letter is intended to outline the agreement we have reached for such coverage. 1. Insurance Coverage and Premium Payments. (a) You have applied for and received a term life insurance policy insuring your life in the face amount of $250,000. This policy was issued by First Colony Life Insurance Company (Policy #2748840), and Surety will be provided with a copy of the insurance application and policy. You are the owner of the policy and Surety has no ownership interest in the policy or the proceeds payable under the policy, but Surety will pay the policy premiums until the earlier of (1) your reaching age sixty-five (65), or (2) a termination of your employment by Surety (subject to the other provisions in this letter). (b) During the term of your employment by Surety, you will provide Surety with a copy of the periodic premium statement, and Surety will either pay same prior to its due date or, if you have previously paid the statement, Surety will reimburse the premium amount to you within thirty days after Surety's receipt of the statement. The premium amount that Surety is obligated to reimburse shall be limited to the cost of level term life insurance from the issuing insurance company for a male who is your age and who qualifies for the company's standard rating for a non-smoker without any restrictive health conditions. 2. Premium Payments - Employment Termination Prior to Age Sixty-Five. The following provisions shall apply with regard to Surety's obligation to pay the premium payments in the event of a termination of your employment prior to your reaching age sixty-five (65). (a) If your employment by Surety is terminated prior to your reaching age sixty-five (65): (1) for any reason other than for Cause (as herein defined) during the period commencing with the effective date of a Change in Control and ending two (2) years thereafter, (2) by you with Good Reason (as herein defined) during the period commencing with the effective date of a Change in Control and ending two (2) years thereafter, (3) as a result of your Disability, or Mr. B. J. Curley January 21, 1997 Page 2 (4) for any other reason other than Cause, Surety shall be obligated to continue the premium payments until the earlier of your reaching age sixty-five (65) or your death. (b) If your employment by Surety is terminated for Cause prior to your reaching age sixty-five (65), Surety shall have no further obligations to pay the premiums on the policy, and Surety's obligations under this Agreement shall terminate on the date of your employment termination. (c) For purposes of this letter, the following terms shall have the following meanings: (1) "Cause" shall mean any act that is materially adverse to the best interests of Surety and constitutes, on your part, common law fraud, a felony or other gross malfeasance of duty. (2) "Change in Control" shall be deemed to have occurred if (A) any "person" (as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended, the "Exchange Act"), other than a trustee or other fiduciary holding securities under an employee benefit plan of Surety, is or becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of Surety representing twenty percent (20%) or more of the combined voting power of Surety's then outstanding voting securities; or (B) during any period of two (2) consecutive years during the term of this letter, individuals who at the beginning of such period constitute the Board of Directors of Surety cease for any reason to constitute at least a majority thereof, unless the election of each director who was not a director at the beginning of such period has been approved in advance by directors representing at least two-thirds (2/3rds) of the directors then in office who were directors at the beginning of the period. (3) "Disability" shall mean your inability to manage Surety's property, business or financial affairs by reason of illness, infirmity, insanity, mental incompetency or otherwise, determined to be (or reasonably expected to be, based upon then available medical information) of not less than twelve (12) calendar months' duration. The initial determination (or reasonable expectancy) shall be determined by the opinion of your regularly attending Physician (defined as a person licensed to practice medicine in Texas). If Surety's Board of Directors ("Surety's Board") disagree with your Physician's opinion, or if you have not engaged a Physician, Surety's Board may engage, at its expense, a Physician to examine you, and you consent to such examination and waive, if applicable, any privilege between the Physician and yourself that may arise as a result of said examination. If you have not engaged a Physician, the opinion of the Physician engaged by Surety's Board shall control. If you have engaged a Physician, and if, after conferring, your Physician and Surety's Physician cannot agree on a final opinion, they shall within thirty (30) days thereafter choose a third consulting Physician whose opinion shall control. The expense of the third consulting Physician shall be borne equally by you and Surety. (4) "Good Reason" shall mean: (A) a material reduction of your duties, responsibilities and status with Surety as they existed immediately before the effective date of a Change in Control; Mr. B. J. Curley January 21, 1997 Page 3 (B) a reduction of your base salary from that in effect immediately before the effective date of a Change in Control; or (C) your relocation to offices of Surety more than thirty (30) miles from the location of Surety's principal offices immediately before the effective date of a Change in Control. 3. Other Documents. Both you and Surety agree to enter into such other documents or agreements that may be necessary to fulfill the provisions of this letter. If this letter properly outlines your understanding of Surety's obligations, please sign one copy of this letter and return it to the undersigned. Sincerely, /s/ C. Jack Bean C. Jack Bean, Chairman Agreed and Accepted: /s/ B. J. Curley - ---------------- B. J. Curley Date: January 21, 1997 EX-10.15 4 STOCK OPTION PLAN FOR DRECTORS EXHIBIT 10.15 SURETY CAPITAL CORPORATION AMENDED AND RESTATED STOCK OPTION PLAN FOR DIRECTORS Section 1. Purposes. The purposes of this Amended and Restated Stock Option Plan for Directors are to promote the continued prosperity of Surety Capital Corporation (the "Corporation") by aligning the long-term financial interests of the directors of the Corporation who are not officers or otherwise employed by the Corporation with those of the stockholders of the Corporation, to provide an additional incentive for such individuals to remain as directors of the Corporation, and to provide a means through which the Corporation may attract well-qualified individuals to serve as directors of the Corporation. Section 2. Definitions. A. The following words and phrases, wherever capitalized, shall have the following meanings respectively, unless the context otherwise requires: 1. "Agreement" means a written agreement which sets forth the terms and conditions of an Annual Option grant under the Plan, including any amendment to such written agreement. Agreements shall be subject to the express terms and conditions set forth herein. 2. "Annual Option" shall mean a stock option granted under the Plan on a Grant Date pursuant to Section 5. All Annual Options granted under the Plan shall be "nonstatutory stock options," i.e., options which do not qualify under Sections 422 or 423 of the Code. 3. "Board" means the Board of Directors of the Corporation. 4. "Business Day" means a Monday, Tuesday, Wednesday, Thursday or Friday, unless such date is a legal holiday, in which event "Business Day" shall be the next succeeding day which is not a Saturday, Sunday or legal holiday. 5. "Change in Control of the Corporation" shall be deemed to have occurred if (A) any "person" (as such term is used in Sections 13(d) and 14(d) of the Exchange Act), other than a trustee or other fiduciary holding securities under an employee benefit plan of the Corporation, is or becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Corporation representing twenty percent (20%) or more of the combined voting power of the Corporation's then outstanding securities; or (B) during any period of two (2) consecutive years, individuals who at the beginning of such period constitute the Board cease for any reason to constitute at least a majority thereof, unless the election of each director who was not a director at the beginning of such period has been approved in advance by directors representing at least two-thirds (2/3) of the directors then in office who were directors at the beginning of the period; (C) the stockholders of the Corporation approve a merger or consolidation of the Corporation with any other corporation, other than a merger or consolidation which would result in the voting securities of the Corporation outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity) at least seventy-five (75%) of the combined voting power of the voting securities of the Corporation or such surviving entity outstanding immediately after such merger or consolidation, or (D) the stockholders of the Corporation approve a plan of complete liquidation of the Corporation or an agreement for the sale or disposition of all or substantially all of its assets. 6. "Code" means the Internal Revenue Code of 1986, as amended and in effect from time to time. 7. "Committee" shall mean the Stock Option Committee of the Board. 8. "Common Stock" means shares of $0.01 par value common stock of the Corporation, subject to adjustment and substitution pursuant to Section 7. 9. "Corporation" means Surety Capital Corporation, a Delaware corporation. 10. "Disabled" or "Disability" means unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration. An individual shall not be considered to be disabled unless he furnishes proof of the existence of a disability in such form as the Committee may require. 11. "Effective Date" means July 16, 1996. 12. "Eligible Person" means a director of the Corporation on a Grant Date who is not on such Grant Date either an officer or otherwise employed by the Corporation or any Subsidiary of the Corporation. "Eligible Persons" means more than one Eligible Person. 13. "Exchange Act" means the Securities Exchange Act of 1934, as amended. 14. "Exercise Price" means, with respect to each share of Common Stock subject to an Annual Option, the price at which such share may be purchased from the Corporation pursuant to the exercise of such Annual Option. 15. "Fair Market Value" means the closing price of the Common Stock on the American Stock Exchange as reported on the composite tape, or if it is not listed on the American Stock Exchange, the closing price on the exchange or established market system on which the Common Stock is then listed; if, however, there is no trading of the Common Stock on the date in question, then the closing price of the Common Stock, as so reported, on the last preceding date on which there was trading shall instead be used to determine Fair Market Value; or if Fair Market Value for any date in question cannot be determined as hereinabove provided, Fair Market Value shall be determined by the Committee by whatever method or means the members, in the good faith exercise of their discretion, at that time shall deem appropriate. 16. "Grant Date" shall mean the date on which an Annual Option is granted. The Grant Date for each Annual Option shall be the first Business Day of each calendar year during the term of the Plan, commencing with calendar year 1997, and shall be July 16, 1996 for calendar year 1996. 17. "Legal Representative" means the "guardian or legal representative" of the grantee as those terms are construed under the Exchange Act who, upon the Disability or incapacity of a grantee, shall have acquired on behalf of the grantee, by legal proceeding or otherwise, the right to exercise the grantee's rights and receive his benefits under the Plan. 18. "Non-Employee Director" means a director of the Corporation, provided such individual (1) is not an officer (as defined in Rule 16a-1(f) under the Exchange Act) of, or otherwise -2- employed by, the Corporation or any Subsidiary of the Corporation and (2) is not directly or indirectly receiving compensation from the Corporation or any Subsidiary of the Corporation for services other than as a director or otherwise has an interest or business relationship which must be disclosed pursuant to Regulation S-K. 19. "Personal Representative" means the executor, administrator or personal representative appointed to administer the grantee's probate estate, or if the individual has no probate estate, then the successor trustee(s) of any revocable living trust the individual established during his lifetime. 20. "Plan" means the plan set forth herein which shall be known as the "Surety Capital Corporation Stock Option Plan for Directors," as same may from time to time be amended. 21. "Qualified Domestic Relations Order" means a "qualified domestic relations order" as defined in the Code. 22. "Subsidiary" means any corporation of which a majority of the outstanding voting capital stock is owned, directly or indirectly, by the Corporation. With respect to non-corporate entities, it means any entity in which the Corporation owns, directly or indirectly, a majority of the equity and voting interest. 23. "Regulation S-K" means adopted by the Securities and Exchange Commission, as amended. B. Except when otherwise indicated by the context, any masculine or feminine terminology when used in the Plan shall also include the opposite gender; and the definition of any term herein in the singular shall also include the plural, and vice versa. Section 3. Shares Available Under the Plan. A. The aggregate number of shares which may be issued and as to which grants of Annual Options may be made under the Plan is 100,000 shares of Common Stock, subject to adjustment and substitution as set forth in Section 7. If any Annual Option granted under the Plan is canceled by mutual consent or terminates or expires for any reason without having been exercised in full, the number of shares of Common Stock subject thereto shall again be available for purposes of the Plan. The shares of Common Stock which may be issued under the Plan may be either authorized but unissued shares or treasury shares or partly each. Section 4. Administration of the Plan. A. The Plan shall be administered by the Committee, which shall have full power and authority, subject to the provisions of the Plan, to supervise the administration of the Plan, to interpret the provisions of the Plan and any Annual Options granted under the Plan, and to prescribe such rules, regulations and procedures in connection with the operation of the Plan as it shall deem necessary and advisable for the administration of the Plan consistent with the purposes of the Plan. Any decision by the Committee shall be final and binding on all parties. No member of the Committee shall be liable for any determination, decision or action made in good faith with respect to the Plan or any Annual Options granted under the Plan. The Committee may delegate the day-to-day administration of the Plan to any individual or individuals it deems appropriate and may retain advisors to advise it. -3- B. The Committee shall consist solely of two (2) or more Non-Employee Directors. C. A majority of the Committee shall constitute a quorum at any meeting, and the acts of a majority of the members present at any meeting at which a quorum is present, or acts approved in writing by all the members of the Committee, shall constitute acts of the Committee. D. The selection of the Eligible Persons to whom Annual Options are to be granted, the timing of such grants, the number of shares subject to any Annual Option, the exercise price of any Annual Option, the periods during which any Annual Option may be exercised and the term of any Annual Option shall be as set forth in the Plan, and the Committee shall have no discretion as to such matters. E. The Committee shall have overall responsibility for keeping records and providing necessary communications to grantees under the Plan. The records of the Committee with respect to the Plan shall be conclusive and binding on all grantees and all persons or entities claiming through or under them. F. The cost of settling Annual Options pursuant to the Plan and the expenses of administering the Plan shall be borne by the Corporation. Section 5. Grant of Annual Options. A. Only Eligible Persons are eligible to receive Annual Options under the Plan on a Grant Date. B. Each Eligible Person on a Grant Date shall automatically be granted, without further action by the Board or the Committee, effective as of such Grant Date, an Annual Option to purchase 2,000 shares of Common Stock, subject to adjustment and substitution as set forth in Section 7. C. If the number of shares then remaining available for the grant of Annual Options under the Plan is not sufficient for each Eligible Person to be granted an Annual Option for 2,000 shares (or the number of adjusted or substituted shares pursuant to Section 7), then each Eligible Person shall be granted an Annual Option for a number of whole shares equal to the number of shares then remaining available divided by the number of Eligible Persons, disregarding any fractions of a share. Section 6. Terms and Conditions Applicable to Annual Option Grants. A. Annual Options granted under the Plan shall be subject to the following terms and conditions: 1. The Exercise Price with respect to each share of Common Stock covered by an Annual Option shall be one hundred percent (100%) of the Fair Market Value of such share as of the Grant Date. 2. The term of each Annual Option shall be ten (10) years, unless terminated earlier pursuant to Section 6.A.5. 3. Except as otherwise provided in this Section 6.A.3., each Annual Option shall be exercisable with respect to all of the shares subject thereto from and after the first anniversary of the Grant Date. An Annual Option, to the extent exercisable, may be exercised in whole or in part. -4- Notwithstanding any other provision contained in the Plan, each Annual Option shall become fully exercisable upon the occurrence of either: (a) the grantee's death or withdrawal from the Board by reason of Disability or (b) a Change in Control of the Corporation. 4. No Annual Option shall be transferable by the grantee otherwise than by will, or if the grantee dies intestate, by the laws of descent and distribution of the state of domicile of the grantee at the time of death or pursuant to a Qualified Domestic Relations Order. All Annual Options shall be exercisable during the lifetime of the grantee only by the grantee or by the grantee's Legal Representative. 5. If a grantee ceases to be a director of the Corporation, for any reason whatsoever, including due to his retirement, Disability, death, resignation or removal from office, any outstanding Annual Options the grantee then holds shall be exercisable by the grantee, or by his Legal Representative or Personal Representative, as the case may be (but only to the extent such grantee is vested therein at the time he ceases to serve as a director of the Corporation) if exercisable by the grantee immediately prior to ceasing to be a director), at any time prior to the expiration date of such Annual Option or within one (1) year immediately following the date the grantee ceases to be a director, whichever period is shorter. An Annual Option held by a grantee who has ceased to be a director of the Corporation shall expire at the end of such exercise period specified in this Section 6.A.5. 6. Subject to the foregoing provisions of this Section 6 and the other provisions of the Plan, any Annual Option granted under the Plan shall be subject to such restrictions and other terms and conditions, if any, as shall be determined by the Committee in its discretion and set forth in an Agreement; except that in no event shall the Committee or the Board have any power or authority which would cause the Plan to fail to be a plan described in Rule 16b-3(c)(2)(ii) under the Exchange Act, or any successor rule. Furthermore, transactions under this Plan are intended to comply with all applicable conditions of Rule 16b-3 or its successors under the Exchange Act. To the extent any provision of the Plan or action by the Committee fails to so comply, it shall be deemed null and void, to the extent permitted by law and deemed advisable by the Committee. 7. All grants of Annual Options shall be evidenced by an Agreement which shall be executed on behalf of the Corporation by a representative of the Committee. B. Annual Options granted under the Plan may be exercised by the grantee or by his Legal Representative or Personal Representative, as the case may be, as follows: 1. Each Annual Option may be exercised by delivery of written notice to the Corporation stating the number of shares of Common Stock covered by the exercise, form of payment, and proposed closing date. 2. The grantee, or his Legal Representative or Personal Representative, as the case may be, shall furnish the Corporation before closing such other documents or representations as the Corporation may require to assure compliance with applicable laws and regulations. 3. The Exercise Price for each Annual Option shall be paid in full upon exercise and shall be payable in cash (including check, bank draft or money order); provided, however, that in lieu of cash, the individual exercising the Annual Option may pay the Exercise Price, in whole or in part, by delivering to the Corporation shares of Common Stock having a Fair Market Value on the date of exercise of the Annual Option equal to the Exercise Price of the shares being purchased; provided, however, any portion of the Exercise Price representing a fraction of a share shall in any event be paid -5- in cash. Delivery of shares may also be accomplished through the effective transfer to the Corporation of shares held by a broker or other agent. The Corporation will also cooperate with any individual exercising an Annual Option who participates in a cashless exercise program of a broker or other agent under which all or part of the shares received upon exercise of the Annual Option are sold through the broker or other agent or under which the broker or other agent makes a loan to such individual. Notwithstanding the foregoing, the exercise of the Annual Option shall not be deemed to occur and no shares of Common Stock will be issued by the Corporation upon exercise of the Annual Option until the Corporation has received payment of the Exercise Price in full. 4. The date of exercise of an Annual Option shall be determined under procedures established by the Committee, and as of the date of exercise the individual exercising the Annual Option shall be considered for all purposes to be the owner of the shares with respect to which the Annual Option has been exercised. 5. Payment of the Exercise Price with shares shall not increase the number of shares of Common Stock which may be issued under the Plan as provided in Section 3. C. The obligation of the Corporation to issue shares of Common Stock under the Plan shall be subject to (i) the effectiveness of a registration statement under the Securities Act of 1933, as amended, with respect to such shares, if deemed necessary or appropriate by counsel for the Corporation; (ii) the condition that any shares to be issued shall have been listed (or authorized for listing upon official notice of issuance) upon each stock exchange, if any, on which the Common Stock may then be listed; and (iii) all other applicable laws, regulations, rules and orders which may then be in effect. Section 7. Adjustment and Substitution of Shares. A. In the event any change occurs in the number of shares of Common Stock outstanding as a result of any stock split, stock dividend, recapitalization, merger, consolidation, reorganization, combination or exchange of shares, split-up, split-off, spin-off, liquidation or other similar change in capitalization, or any distribution to holders of Common Stock other than cash dividends, the number or kind of shares that may be issued under the Plan pursuant to Section 3, including shares covered by existing Annual Options, shall be automatically adjusted to preserve the proportionate interests of the grantees in the Corporation as represented by their outstanding Annual Options, and the proportionality of the share pool under the Plan in relation to the total number of shares outstanding. B. If the outstanding shares of the Common Stock shall be changed into or become exchangeable for a different number or kind of shares of stock or other securities of the Corporation or another corporation, whether through reorganization, reclassification, recapitalization, stock split-up, combination of shares, merger or consolidation, then there shall be substituted for each share of the Common Stock set forth in Section 3, including shares covered by existing Annual Options, the number and kind of shares of stock or other securities into which each outstanding share of Common Stock shall be so changed or for which each such share shall become exchangeable. C. In case of any adjustment or substitution as provided for in Section 7.A. or 7.B., the aggregate Exercise Price for all shares subject to each then outstanding Annual Option prior to such adjustment or substitution shall be the aggregate Exercise Price for all shares of stock or other securities (including any fraction) into which such shares shall have been converted or which shall have been substituted for such shares. Any new Exercise Price per share shall be carried to at least three decimal places with the last decimal place rounded upwards to the nearest whole number. -6- D. If the outstanding shares of Common Stock shall be changed in value by reason of any spin-off, split-off or split-up, or dividend in partial liquidation, dividend in property other than cash or extraordinary distribution to holders of Common Stock, the Committee shall make any adjustments to any then outstanding Annual Option which it determines are equitably required to prevent dilution or enlargement of the rights of grantees which would otherwise result from any such transaction. E. No adjustment or substitution provided for in this Section 7 shall require the Corporation to issue or sell a fraction of a share or other security. Accordingly, all fractional shares or other securities which result from any such adjustment or substitution shall be eliminated and not carried forward to any subsequent adjustment or substitution. F. Except as provided in this Section 7, a grantee shall have no rights by reason of issuance by the Corporation of stock of any class or securities convertible into stock of any class, any subdivision or consolidation of shares of stock of any class, the payment of any stock dividend or any other increase or decrease in the number of shares of stock of any class. Section 8. Amendment and Termination. A. The right to amend the Plan at any time and from time to time and the right to terminate the Plan at any time are hereby specifically reserved to the Board; provided, however, that no such termination shall result in the cancellation of any outstanding Annual Options theretofore granted under the Plan; and provided further that no amendment of the Plan shall cause Annual Options granted under the Plan to directors of the Corporation not to qualify for the exemption provided by Rule 16b-3, or any successor rule. No amendment or termination of the Plan shall, without the written consent of the holder of an Annual Option theretofore granted under the Plan, adversely affect the rights of such holder with respect thereto. B. Notwithstanding anything contained in the preceding paragraph or in any other provision of the Plan or in any Agreement, the Board shall have the power to amend the Plan in any manner deemed necessary or advisable so that Annual Options granted under the Plan qualify for the exemption provided by Rule 16b-3 (or any successor rule relating to exemption from Section 16(b) of the Exchange Act), and any such amendment shall, to the extent deemed necessary or advisable by the Board, be applicable to any outstanding Annual Options theretofore granted under the Plan notwithstanding any contrary provisions in any Agreement. In the event of any such amendment to the Plan, the holder of any Annual Option outstanding under the Plan shall, upon request of the Committee and as a condition to the exercisability of such Annual Option, execute a conforming amendment in the form prescribed by the Committee to the Agreement referred to in Section 6.A.7. within such reasonable time as the Committee shall specify in such request. Section 9. Effective Date and Duration of Plan. A. The Plan shall become effective on the Effective Date and shall continue until all Annual Options granted under the Plan have been exercised or have lapsed or otherwise been terminated pursuant to the Plan. B. Expiration or other termination of the Plan shall not affect outstanding Annual Options. -7- Section 10. Miscellaneous. A. Nothing in the Plan, in any Annual Option granted under the Plan, or in any Agreement shall confer any right to any person to continue as a director of the Corporation, or interfere in any way with the rights of the stockholders of the Corporation to elect and remove directors. B. The Corporation shall have the right, in connection with the exercise of an Annual Option, to require the grantee to pay to the Corporation an amount sufficient to provide for any withholding tax liability imposed with respect to such exercise. C. To the extent that federal laws (such as the Code and the federal securities laws) do not otherwise control, the Plan shall be governed and construed in all respects in accordance with Texas law. -8- STOCK OPTION AGREEMENT This STOCK OPTION AGREEMENT ("Agreement") is made this ___ day of January, 199___ between Surety Capital Corporation, a Delaware corporation (the "Corporation"), and _______________ (the "Director"). WHEREAS, on July 16, 1996 the Board of Directors of the Corporation adopted the Stock Option Plan For Directors of the Corporation, as amended and restated in its entirety by the Board of Directors of the Corporation on January 21, 1997 (the "Plan"); and WHEREAS, the Plan provides for the automatic annual grant of non-statutory stock options to the directors of the Corporation who are not employees of the Corporation or any of its subsidiaries; and WHEREAS, the Director is eligible to participate under the Plan; and WHEREAS, on January ___, 199___, an annual Grant Date (as defined in the Plan) under the Plan, the Director was granted an annual option to purchase 2,000 shares of common stock, $0.01 par value, of the Corporation (the "Common Stock"), subject to the restrictions set forth in the Plan; and WHEREAS, the Corporation and the Director desire to memorialize the granting of such annual stock option, and the terms and conditions relating thereto; NOW, THEREFORE, in consideration of the mutual covenants hereinafter set forth and for other good and valuable consideration, the parties hereto agree as follows: 1. Grant of Option. The Corporation hereby irrevocably grants to the Director the option (the "Annual Option") to purchase all or any part of an aggregate of 2,000 shares of Common Stock (such number being subject to adjustment as provided in Section 7 of the Plan) on the terms and conditions herein set forth and subject further to all of the terms and provisions of the Plan which are incorporated herein by reference for all purposes. 2. Exercise Price. The exercise price of the Common Stock covered by the Annual Option shall be $_________ per share, which is one hundred percent (100%) of the Fair Market Value (as that term is defined in the Plan) of such Common Stock on the date of grant thereof. 3. Term of Annual Option. The term of the Annual Option shall be for a period of ten (10) years from the date hereof, subject to earlier termination as herein provided. If the Director ceases to serve as a director of the Corporation, for any reason whatsoever, including due to his retirement, Disability (as that term is defined in the Plan), death, resignation or removal from office, the Annual Option granted hereunder may be exercised by the Director at any time prior to the expiration date of such Annual Option or within one (1) year immediately following the date the Director ceases to be a director of the Corporation, whichever period is shorter. The Annual Option held by the Director in the event he ceases to be a director of the Corporation shall expire at the end of the exercise period specified herein. Subject to the foregoing limitations, each Annual Option may be exercised at one time or on several successive occasions. 4. Vesting. The Annual Option is exercisable with respect to all of the shares of Common Stock subject thereto from and after the first anniversary of the date hereof. Notwithstanding the foregoing, the Annual Option shall become fully exercisable upon the occurrence of either (a) the Director's death or withdrawal from the Board of Directors of the Corporation by reason of Disability or (b) a Change in Control of the Corporation (as that term is defined in the Plan). 5. Payment of Exercise Price. The exercise price of the shares Common Stock as to which the Annual Option may be exercised shall be paid in full in cash, or by the delivery of previously owned shares of Common Stock of the Corporation, at the time of exercise and as provided by the Plan. The Plan also permits "cashless exercises" of the Annual Option, which involves a program through which the shares of Common Stock underlying the Annual Option are delivered to a broker as collateral for a margin loan which is used to pay the exercise price or, alternatively, the broker may sell a portion of the shares of Common Stock underlying the Annual Option received and use the proceeds from the sale to pay the exercise price of the Annual Option. 6. Further Restrictions. The Annual Option may not be exercised unless at the date of exercise a registration statement on Form S-8 under the Securities Act of 1933, as amended (the "Act"), relating to the shares covered by the Annual Option shall be in effect, or if, in the opinion of counsel for the Corporation, the exercise and issuance of Common Stock would be exempt from registration requirements under the Act and under applicable securities laws. The Corporation is under no obligation to register the shares covered by the Annual Option under the Act. 7. Nontransferability. The Annual Option shall not be transferable by the Director otherwise than by will, or if the Director dies intestate, by the laws of descent and distribution of the state of domicile of the Director at the time of death or pursuant to a Qualified Domestic Relations Order (as defined in the Plan). All Annual Options shall be exercisable during the lifetime of the Director only by the Director or by the Director's Legal Representative (as defined in the Plan). 8. Method of Exercising Annual Option. This Annual Option may be exercised by written notice to the Corporation on the form as attached to this Agreement, as same may be changed from time to time by the Committee, and subject to the terms and conditions set forth in Section 6 of the Plan. 9. Other Matters. The Director acknowledges receipt of a copy of the Plan and represents that the Director is familiar with the terms and provisions thereof. The Director hereby accepts this Annual Option subject to all of the terms and provisions of the Plan. The Director hereby agrees to accept as binding, conclusive and final all decisions and interpretations of the Board of Directors of the Corporation and, where applicable, the Committee (as that term is defined in the Plan), upon any questions arising under the Plan or this Agreement. As a condition to the issuance of shares of Common Stock of the Corporation under this Agreement, the Director authorizes the Corporation to withhold in accordance with applicable law from any regular cash compensation payable to him any taxes required to be withheld by the Corporation under federal, state or local law as a result of his exercise of this Annual Option. IN WITNESS WHEREOF, the Corporation has caused this Agreement to be duly executed by its officers thereunto duly authorized, and the Director has hereunto set his hand, all on the date and year first above written. CORPORATION: SURETY CAPITAL CORPORATION By:_______________________ C. Jack Bean, Chairman -2- DIRECTOR: ------------------------- ------------------------- ------------------------- (Address) -3- EXERCISE FORM (To be completed and delivered to the Corporation for exercise) The undersigned hereby: (1) irrevocably subscribes for ______ shares of the Common Stock pursuant to his Stock Option Agreement dated ________________, 19___, and encloses payment of $__________ therefor; (2) requests that a certificate for the shares be issued in the name of the undersigned and delivered to the undersigned at the address below; and (3) if such number of shares is not all of the shares purchasable under the Stock Option Agreement, that a new Stock Option Agreement of like tenor for the balance of the remaining shares be issued in the name of the undersigned and delivered to the undersigned at the address below. Date:____________________ ________________________ ________________________ ________________________ (Address) EX-21 5 SUBSIDIARIES EXHIBIT 21 SUBSIDIARIES OF SURETY CAPITAL CORPORATION Jurisdiction Subsidiary of Organization ---------- --------------- Surety Bank, National National Banking Association Association EX-23 6 CONSENT OF COOPERS & LYBRAND EXHIBIT 23 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in the registration statements of Surety Capital Corporation on Form S-8 (File No. 33-35415), Form S-8 (File No. 33-63695), Form S-8 (File No. 333-20615), Form S-3 (File No. 33-89264) and Form S-3 (File No. 33-44893) of our report dated January 21, 1997, on our audits of the consolidated financial statements of Surety Capital Corporation as of December 31, 1996 and 1995, and for the years ended December 31, 1996, 1995 and 1994, which report is included in the Annual Report on Form 10-K for the year ended December 31, 1996. We also consent to the reference to our firm under the caption "Experts." /s/ COOPERS & LYBRAND L.L.P. COOPERS & LYBRAND L.L.P. Fort Worth, Texas March 28, 1997 EX-24 7 POWER OF ATTORNEY EXHIBIT 24 SPECIAL POWER OF ATTORNEY The undersigned hereby appoint C. Jack Bean and Bobby W. Hackler, and each of them severally, as attorneys and agents for the undersigned, with full power of substitution, for and in the name, place and stead of the undersigned, to sign and file with the Securities and Exchange Commission the Annual Report on Form 10-K of Surety Capital Corporation (the "Form 10-K") for the fiscal year ended December 31, 1996, with said attorneys and agents to have full power and authority to do and perform in the name of and on behalf of the undersigned, every act whatsoever necessary or advisable to be done in the premises as fully and to all intents and purposes as the undersigned might or could do in person, such power to extend to the execution of any amendment to the Form 10-K. Executed this 21st day of January, 1997. /s/ C. Jack Bean ---------------- C. Jack Bean /s/ William B. Byrd ------------------- William B. Byrd /s/ Bobby W. Hackler -------------------- Bobby W. Hackler /s/ Joseph S. Hardin -------------------- Joseph S. Hardin /s/ G. M. Heinzelmann, III -------------------------- G. M. Heinzelmann, III /s/ Michael L. Milam -------------------- Michael L. Milam /s/ Garrett Morris ------------------ Garrett Morris /s/ Cullen W. Turner -------------------- Cullen W. Turner EX-27 8 FDS
9 (Replace this text with the legend) YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 6,094,457 285,842 16,772,000 0 16,221,273 22,561,270 22,763,252 105,696,491 (2,544,803) 176,439,310 155,690,341 0 1,518,417 0 0 0 57,637 19,172,915 176,439,310 10,779,721 3,610,641 0 14,390,362 5,855,077 5,361,689 9,028,673 135,000 0 8,135,012 2,636,115 2,636,115 0 0 1,697,987 0.32 0.32 6.20 144,000 112,000 0 0 702,927 229,418 61,565 1,284,774 1,284,774 0 0
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